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Conquer complexity: Get briefed on the latest accounting updates

In the accounting world, the rules are ever changing. Large in scope and long awaited, the new rule for recognizing revenue continues to get clarifications in the months leading up to its effective date. The new leasing standard is finally here as well and sharing the attention. Those are just the biggies—the Financial Accounting Standards Board has been coming out with a flurry of changes in recent months, and regulators are paying attention to what you are doing with them. There’s a ton of information to follow to stay compliant.

How equipped finance teams are to keep up with all the moving parts varies quite a bit. They oftentimes find it beneficial to lean on technical accounting experts who can decipher the never-ending landscape and help with interpretations. Such experts can help them stay on track in understanding the latest accounting refinements, transition-method choices and effective dates. Diana Gilbert, senior consultant at RoseRyan and head of our Technical Accounting Group, helped many companies get up to speed during the June 2 webinar, “Demystifying the Latest Major Accounting Changes.”

This fast moving, 90-minute, all-out binge covered the latest twists and turns that have come out from FASB and regulators over the past year. Some changes have simplified things. Others will have a narrow effect. And many will force finance teams to do some soul searching as the deadlines near. Contracts and compensation plans may need to be revisited.

Diana filled in listeners (most of whom were from life sciences and technology companies) on the five topics below, along with other changes, and gave timely advice along the way.

Revenue recognition: Companies that don’t have a game plan for the new revenue recognition standard are running out of excuses. The SEC has been “aggressively” referencing the new rule in recent speeches to let companies know they will be watching what gets said in disclosures, Diana said. Boilerplate, vague language won’t cut it much longer.

“This has been out there since 2014, so they are going to question why you’re still evaluating it now,” she said. “If you’re honestly, sincerely evaluating it, then just be prepared for the questions. But if you’ve done your evaluation and pretty much do understand the impact, then think about including more detailed disclosures, particularly about decisions you’ve already made,” such as the transition method the company will be taking and the planned adoption date.

Leases: The new standard finalized in February will bring what we refer to as operating leases today onto the balance sheet. The rule applies to leases of property and equipment with terms of at least one year and centers around the lessee’s “right of use” of an item (the obligation to pay for that right is what will appear on the liability side of the balance sheet).

The new rule could change behavior, Diana predicted. “Think about it. If you’re going to have it on the balance sheet anyway, are you still going to lease it or would you buy it outright?” she said. “You might create new forms of leases that are clearly less than a year, without the option to renew, and you’ll have to deal with the issue every year. That may make sense for inconsequential arrangements. It will be interesting to see what happens going forward.”

Financial instruments: Public companies will begin following new rules on classifying and measuring financial instruments for filings submitted in 2018, and private companies will do so a year later. Equity investments that are not consolidated are generally going to be measured at fair value through earnings. In some ways, disclosure requirements have been simplified with the rule changes—companies won’t have to disclose their methods and significant assumptions for estimating fair value—and in other ways they have expanded.

Stock-based compensation: Companies have “a grocery bag of different changes” to deal with when it comes to improvements to employee share-based payment accounting, Diana warned. The most significant relates to deferred tax assets. When the changes take effect, companies will no longer record excess tax benefits and certain tax deficiencies resulting from share-based awards in additional paid-in capital (APIC). APIC pools are eliminated under the changes.

Diana said this is a “huge simplification” in terms of tracking share-based compensation, but the downside is the potential for more volatility in the income statement. This particular change is applied prospectively from the date of adoption (which begins after December 15, 2016, for public companies).

SEC comments: The SEC staff has always tended to question areas that involve judgment and subjectivity, Diana noted. In recent years, in particular, they have been scrutinizing the statement of cash flows and whether companies’ internal controls are effective. Diana recommended that companies be as clear as possible and use tables and charts to help tell their story.

“Comment letters come about because they don’t understand what’s happening,” Diana said. “Or it’s a complex area and they’re going to ask you questions whether you like it or not.”

Keeping tabs on regulators’ areas of emphasis and accounting standard-setters’ changes takes time and effort. Things are in constant motion, and companies need to stay on top of it all. That’s how they can help minimize the questions that come from regulators and any uncertainty that may arise during implementation. To save time and effort in understanding the latest accounting standards (changes through June 1, 2016), feel free to check out the 90-minute replay of “Demystifying the Latest Major Accounting Changes” here.

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An executive briefing: Demystifying the latest accounting rules and what you need to think about

A flurry of effective dates, interpretive guidance and new rules—companies are processing a lot of information coming their way from the Financial Accounting Standards Board and the Securities and Exchange Commission. Some of the changes have been in the works for ages (we’re talking about you, revenue recognition), and now there are overlapping implementation periods and many, many questions on the part of finance teams that need to put all these rules into place. Is your head spinning yet?

Finance professionals not only need to make sense of the rules, but they also want to know what their auditors think of them and how their peers are going to approach them. For the accounting change biggies—like the new leasing standard—some companies will need to revisit their internal processes and they’ll have some tough choices to make on how they’ll proceed (Should any contracts be changed? How much do investors need to know now about the potential effect on the company’s balance sheets?). The impacts will vary by company and can vary widely. Some companies are getting surprised by how much.

We’ve noted before that FASB has been in the process of clearing to-do items off its own agenda and dumping them onto finance teams’ plates, making this the time to get a handle on it all. That’s why we have developed a 90-minute webinar for senior finance executives called “Demystifying the latest accounting rulings—what finance leaders need to know” so they can get a grip on what’s happening and how to deal with it. This online event will break down the newly effective standards and proposals from FASB plus updates from the SEC and the Public Company Accounting Oversight Board. Senior consultant Diana Gilbert, who leads our Technical Accounting Group, will guide you through it on Thursday, June 2, 10:00-11:30am PT. Read more about this webinar and register here: bit.ly/AcctgWebinar.

Get ahead of these changes. With looming, varied effective dates, you’ll need to prioritize and understand the impacts, all while keeping watch for more updates coming down the pike.

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What CFOs need to know about the new leasing standard

One loud giant thud is the sound you’d hear if you printed out all 485 pages of the new lease accounting standard and threw it on your desk.

Multiple giant thuds. That’s what we’ll all be hearing when trillions of dollars worth of leases land on many companies’ balance sheets in 2019. That’s when public companies will need to bring right-of-use assets and associated obligations onto the balance sheet and out of the footnotes. (Privately held companies get an extra year to comply.) The full effects are yet to be known, but two things are known for sure: balance sheets will get heavier and many questions for CFOs will follow.

In the works for over a decade, the new standard issued by the Financial Accounting Standards Board in February will affect almost every company. Lessees will feel it the most. As I mentioned in a recent article in ComplianceWeek (sub. required), the new standard will be “pretty pervasive.” The rule addresses leases of property and equipment that are 12 months or longer.

Many companies will be bringing their operating leases onto their balance sheets, which will make them appear more leveraged than under historical GAAP. The new guidance will lead to “a more faithful representation of an organization’s leasing activities,” according to FASB Chair Russell G. Golden.

One of the most common examples given while standard-setters ironed out the details of the new rule was the leasing of airplanes. For aircraft leased for several years but not for their entire “life,” airlines did not have to show their ongoing obligation on their balance sheet. Some viewed this allowance of off-balance-sheet reporting as misleading (this is not just an issue for airlines: Amazon will have to factor in the new rule as it moves forward with its reported plans to lease 20 Boeing 767 planes).

Although it will be awhile before we see the full extent of the standard’s changes in publicly filed financial statements, CFOs are going to have to be ready to answer some questions about how it will affect their company and how they’re going to deal with it. For now, companies will need to add it to their new accounting pronouncement disclosures. And then there’s the detailed work ahead in figuring out what leases the company has and evaluating them.

In the months ahead, companies will need to thoughtfully review their current lease agreements and consider whether any will need to be reclassified under the new rule. It may need to be a cross-functional effort. Companies may want to revisit the wording in some contracts. They may notice that some debt covenants could be affected. There’s some time to get ahead of the changes—but only if the work is put into it now.

Feel like 2019 is a ways off? Some long-term leasing agreements you have in play now could be affected as the standard requires modified retrospective adoption. Comparative financial statements will accompany the reports when it comes time to comply with the rule. And by then the time to transition to this new way will seem to have flown by.

Diana Gilbert has been a member of the RoseRyan dream team since 2008 with almost 30 years of professional experience. Frequently tapped for her insights by Compliance Week, Diana excels at technical accounting, revenue recognition, SOX/internal controls, business systems and process improvements.

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Get ready: FASB is dumping some big items on your to-do list

The Financial Accounting Standards Board has a bunch of resolutions that affect many companies. The board is offloading some of their weightier projects that have taken up a lot of time (several years!) on their docket.

Fortunately, they are giving financial statement preparers a lot of time to come to terms with the changes ahead, providing a couple of years to implement new standards for lease accounting and the classification and measurement of financial instruments.

The most highly anticipated one—the new leasing standard—will result in some companies looking more leveraged on their balance sheets, starting with their 2019 financial reports (privately held companies get an extra year). Companies that lease any property and equipment for one year or more will be impacted. This will be a really big deal.

In the works for a decade (the SEC called for a revamped standard in 2005), the new leasing rule created a rift during the ongoing convergence effort between FASB and the International Accounting Standards Board, leading the two boards to come out with two different standards. Call it a divergence if you will.

The IASB recently released their final standards and the FASB’s is expected this quarter. Companies will appear to be burdened by more debt than they do now, as disclosing leases only in footnotes will no longer be acceptable under GAAP. Studies estimate that the changes will raise the reported liabilities of U.S. public companies by $1.5 trillion to $2 trillion.

It is expected that the new rule will take more effort to put in place than the new revenue recognition standard (and that’s saying something). Consider that every lease must be reviewed with assumptions updated each reporting period. Under the new guidance, lessees will be required to present right-of-use assets and lease liabilities on the balance sheet.

FASB has passed down a couple of other big agenda items when it released its rules concerning financial instruments last month. Although not in the works as long as the pending changes to lease accounting, this project was also divisive for FASB and IASB. For FASB’s part, the board will require companies to follow new rules on classifying and measuring financial instruments in 2018 and financial instrument impairment in 2019.

FASB’s standard for how to classify and measure financial instruments will be relevant to most companies, in particular those that have equity method investments that are not currently measured at fair value. Current fair value measurements and disclosures can be confusing to investors, and the new rules are intended to simplify things. Companies can adopt parts of the standard early if they wish.

As for the new revenue recognition standard, the Joint Transition Resource Group had its last scheduled meeting in Q4 2015 and will reconvene if new issues arise around implementation of the new rule. The FASB is expected to finalize proposed amendments to the standard this quarter. So the rules are settling, and there is no more reason to delay your implementation efforts. You are already in the first fiscal year that will be effected by the new standard when you implement in 2018.

FASB’s agenda will appear a bit thinner by the second quarter of 2016, while yours has grown. Let the fun of implementation begin!

Diana Gilbert has been a member of the RoseRyan dream team since 2008 with almost 30 years of professional experience. Frequently tapped for her insights by Compliance Week, Diana excels at technical accounting, revenue recognition, SOX/internal controls, business systems and process improvements.

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Putting the E in “revenue”: A big challenge of the new rev rec standard

Accounting professionals who have been involved with revenue for many years can recite the four criteria for revenue recognition as quickly as they can their children’s names—it just becomes second nature. For people less familiar with the process, I have used a mnemonic—it’s like learning your ABC’s but without the AB—you can sort the criteria into Collection, Delivery, Evidence, and Fixed Price (C, D, E, F). Gimmicky, but it works.

Well, we’re all going to need new hints for taking on the new revenue recognition standard when it goes into effect. The adoption date may be a ways off with FASB’s recently announced one-year delay, but finance teams still need to get their heads around the changes. Implementation challenges are ahead, and contingent revenue related to bonuses and penalties will be particularly challenging for some organizations.

The new big “E”: Estimates
While many of the same concepts will still exist, the framework of the standard moves to a five-step process rather than relying on criteria. So while collectability, delivery, evidence of the arrangement, and even some aspects of fixed or determinable pricing still come into play, that last aspect is where I see the biggest challenges.

If I had to create a new term for what we currently view as the “fixed or determinable” part of rev rec, I would call it “fixed or estimable” for the new standard. It requires, in almost all circumstances, entities to estimate the amount of contract consideration that they believe they are entitled to (assuming that recording such revenue would not likely result in a significant reversal of revenue in the future). So, there will be more judgment involved and this will require a change in practice.

Much has been written about how the new standard will require organizations to not only make many more estimates but have systems to support those estimates, provide more disclosures in their filings, and have controls to ensure that the system that supports the estimates is controlled—this isn’t about someone just throwing a dart at a board! This is why now is the time—while we all have it—to take a close look at your systems and processes and decide whether they’ll need to be modified to make room for the flexibility that’s needed when you’re dealing with estimates.

You say tomatO, I say tomAto: A bonus and penalty can be the same thing!
How is this different than current practice? Consider this pretty straightforward example of how a contract with a bonus (or penalty) provision would be treated today versus the new standard. Keep in mind this deal (from an economic perspective) can be structured using either a bonus or a penalty.

Assume Customer A purchased a single hardware element that qualified for separate accounting (i.e., it is not a multi-element arrangement). The vendor structures the deal at a fixed price of $10K for Customer A with the understanding if the product meets certain performance parameters after 60 days (i.e., uptime), the vendor gets a bonus of $2K. Then consider a deal that same vendor makes for Customer B: It charges the organization $12K with the understanding it would have to give back $2K if those same parameters are not met.

Current U.S. GAAP treats both these contracts the same—it is a classic “substance over form” example and the reality is that both customers negotiated the same deal. But there’s that $2K unknown; since it does not meet the fixed or determinable criterion, the vendor cannot count the $2K contingent amount as revenue until that 60-day contingency passes (at which point both the vendor and the customer will know if the uptime spec was met). It’s the same scenario even if the vendor can show that 100% of the time it has achieved the specs it’s promising.

Now, fast-forward to the new standard—this contingent revenue will have to be estimated and recorded up-front. The result is binary—either the vendor records the $2K payment or not. This time, if the vendor has a strong history of meeting its performance specs, it would book the $2K. Or it could estimate a weighted-average probability amount if the amount it expects to receive falls within a range of possible outcomes. This would be more appropriate if the contract bonus depended on a percentage of spec achieved (i.e., a different example).

The bottom line
In almost all companies, a purchase order is a big factor for determining the ceiling for revenue recognition. Using our super-simple example above (if only all rev rec determinations were that easy!), the vendor may receive a PO of $10K from Customer A but $12K from Customer B. But let’s say Customer A ends up following up with a second PO for $2K when the performance bonus was earned—just as the vendor predicted. Under the new rule, the vendor would have already recorded $12K for that contract even though the PO said something else—this discrepancy could create challenges for many companies from a systems perspective.

Also important to understand is that the first step of the new standard—determining the contract—contains the old collectability criterion in it. Put another way, you can’t have a contract if you don’t have a contractual right to payment with a credit-worthy customer. In our example, the contract value is “potentially” $12K regardless of the amount and timing of POs received.

Ultimately, companies need to have a process in place and should look at how their ERP system may handle situations like this. Manual, off-line, Excel-based tracking may seem like a reasonable solution, but in my experience, it introduces too many risks for errors and inefficiencies.

In addition to the accounting considerations, the new standard could let sales organizations give customers more contracting options. Often, the finance or accounting organization has had to “hold back” certain deal structures to ensure revenue rules were met. Given the focus on the big “E”—estimates—in the new standard, many organizations will find that they can create contracts with more value for their customers and alter contractual language, win more business and, in turn, increase profits—although that is just my estimate!

Looking for more insight on the new revenue recognition standard? RoseRyan and FinancialForce.com teamed up for a new report that gives companies a starting point for planning for the changes, explaining who should be involved, what areas of the company should be impacted and how to move forward. Click here to download the report: Quick guide to revenue recognition.

John Cook is a member of the RoseRyan dream team. He is a CPA with over 25 years of experience working in finance and accounting organizations in Silicon Valley with a focus on operational finance and technical accounting.

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Coming up with a game plan for revenue recognition

Consider taking the new revenue recognition rules out for a spin. It could be a short test drive, with just a sample of current contracts sitting in the passenger seat so you can see how the changes feel and how drastic they may or may not be to your company.

The point is to explore the impact of the new rules and determine if any of your processes, systems and contracts need to be adjusted before the rules go into effect. It’s much easier to consider the changes now than when a deadline is staring you in the face. That was the overriding theme of a recent Proformative.com webinar called “Revenue Recognition in 2015: What Your Company Needs to Get Done” with speakers Steve Jackson, a senior consultant at RoseRyan, and Mike O’Brien, General Manager, Financial Management Applications, at FinancialForce.com, a cloud ERP provider on the Salesforce1 Platform.

Changing your view of revenue
It’s been nearly a year since standard-setters released the new rules last May. Since then, companies have, at the very least, digested the literature (if not, it’s time to get cracking!), but what they’ve done next varies. Some have pressed the Financial Accounting Standards Board to make tweaks and give companies more time to adopt the standard while others are moving full speed ahead and are exploring the impacts.

During the Proformative event, several hundred attendees were polled on their plans. Just 15% of the webinar attendees said they have a plan in place to deal with the new rules while 35% said they’re still mulling over the guidance and observing what other companies are doing. “For those of you who are early in the process or don’t know what to do yet, don’t fear, you are not alone,” O’Brien said. “I talk to a lot of customers every day, and some are further down the line, but in fact some companies haven’t fully embraced the standards from a systems perspective.”

As expected with a rule of this size and significance, FASB and the International Accounting Standards Board are hearing about implementation issues and considering whether to clarify anything (most recently, FASB agreed to propose an update that would make clearer how to account for licenses of intellectual property and identify performance obligations).

We’ll all have to stay tuned. Under the current timeline, public companies’ financial statements won’t reflect the changes until 2017 (beginning with reporting periods that start after December 15, 2016; private companies get an extra year). Finance and accounting teams need the time between now and then to get a grip on potential impacts, prepare their systems for the changes, and give investors a head’s up for any shift in financial results.

One way to truly understand the impact? “Go through the motions of closing a month as if the new rules were in effect now,” Jackson suggested. “It’s important that you try to understand the impact so you’ll know what you’re dealing with when building your full plan,” he said.

For those 2017 reports, public companies will be showing three years worth of comparative information, “so activity that is taking place now will be part of the financial presentation” in that first year, Jackson noted.

Where to begin
Jackson recommended viewing the adoption as you would a big tech system upgrade or an acquisition of another company. Like those big projects, you need to do your homework, put a team in place to tackle it and hatch a plan. For some companies, Jackson explained, the work may involve a just few people while others will need to supplement their skillsets with outside resources.

Ideally, the person spearheading the endeavor should have strong project management and communication skills. “As you implement the new standard, your revenue could be different in 2017,” Jackson said. “So as you forecast to shareholders and analysts what you believe revenue and earnings per share are going to be, that needs to be incorporated.”

To get to that point, companies should take these actions:

  • Come up with an overall plan and calendar. Treat it like a big project, which it is.
  • Formulate your team and make sure all other relevant departments are involved. Some companies may need to include sales, IT, human resources (if any compensation plans are tied to revenue), legal, tax, investor relations. Also consider getting other executives, the audit committee and external auditors up to speed with your plans and evaluations.
  • Manage your investor communications. Give outside observers a sense of the potential impact. So far, as required under the new rules, public companies are hinting at how the new standard will affect them. They have either said, in general terms, that it could have a significant impact on their financial statements or won’t have a material impact.
  • Check all your financial systems to see if they can accommodate the changes and what your vendors have planned. “You don’t want to switch on new software the first day of the reporting quarter,” O’Brien said. “If your vendor doesn’t plan to comply or make the application available to you, you need to know now.”

The overall message? It is best to plan ahead. Not every company will be deeply affected by the new changes, but every company should be considering the level of impact at this time.

Watch the replay “Revenue Recognition in 2015: What Your Company Needs to Get Done,” which took place on Proformative.com, a website for senior finance executives.

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It was high time the FASB eliminated ‘extraordinary items,’ and they finally did

Companies will no longer have to call out extraordinary items on the income statement following the Financial Accounting Standards Board’s recent issuance of an accounting standards update. This change, which affects transactions that are considered both unusual and infrequent, goes into effect for fiscal periods beginning after December 15, 2015.

As someone who has been on all sides of the fence having to decide how to account for these items (I have been an auditor, CFO and investor) I must admit I am not sad to see the separate accounting of them, located after Income from Continuing Operations, and net of tax, go away. I have always felt that accounting for extraordinary items the way we’ve had to is, well, kind of extraordinary!

My reasonings for thinking this way are twofold. First, I am a strong believer in simplified accounting, and this change definitely simplifies the accounting. Second, in my view anything to do with your continuing business should be accounted for as an integrated part of your continuing business, and just because a transaction is unusual and infrequent does not give it the right to be accounted for separately.

My definition of unusual and infrequent may be different to yours, and that’s the problem—the rules that have been in place have a significant element of subjectivity to them. To me, accounting for extraordinary items has been very similar to applying soccer’s offside rule. Under that rule, you are not offside if you are not interfering with play. That’s a very subjective judgment, and your view of interfering in a situation may be different than mine. I acknowledge that I am a little extreme on this—to me if you are on the pitch, you are by definition interfering with play. That’s probably a big reason why I never became a referee!

I once had a very long debate (you could also call it an argument), with a Big 4 audit partner over whether a transaction was an extraordinary item while I was the CFO of a public company. The discussion lasted a week, and in the end the partner punted it to another partner who ended up agreeing with me. I’d like to say it was a win for me, but we had both wasted hours discussing this issue.

Adding insult to injury, I couldn’t believe it when the partner subsequently tried to bill me for the time we spent discussing it. As you can imagine, that created another discussion. I finally got the billing eliminated, but what a waste of time and effort. I am sure many others have had the same experience as me. The good news is that no one will have to again when the new rule changes come in to play, so hopefully a side benefit will be that audit costs will come down a little as well.

By the way, when this rule change goes into effect—making extraordinary items no longer necessary—US GAAP will match IFRS rules. Yes, the continuing operations section of an income statement will look more lumpy, but it will reflect better what is going on in the business, and that is what accounting should do and all we can ask it to do.

Stephen Ambler is a director at RoseRyan, where he manages the development of the firm’s “dream team” of consultants. His interim CFO stints at RoseRyan have included a social media company and the management of the financial integration process at a company acquired by Oracle. He previously held the CFO position for 13 years at Nasdaq-listed companies.

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Hot topics for finance departments in 2015

There’s a tension for finance organizations that go public. Throughout the year, they are faced with new rules from accounting standard-setters, new guidance from accounting firms and new direction by regulators that could affect them directly.

Last year was no different as the Financial Accounting Standards Board issued 17 Accounting Standards Updates (ASUs), up from 12 in 2013, including a real biggie (the new revenue recognition standard), and the regulators continued to be active and forceful. On top of this, privately held companies are getting more rules sent their way, and an increasing number are considering whether they too should get involved in the public markets.

No matter where your organization lies in its cycle—whether you’re in a startup or a fully fledged publicly traded company past the early, shaky days of trading—you have many issues to face in the coming year as your team puts together its financial reports and communicates with investors. Here are recent changes you should keep in mind, depending on your situation:

Taking on the new revenue recognition rule: By now companies should be past the evaluation stage and their plan to implement should be nearing completion. They should start tracking their transactions to see how they’ll play out under the new guidance.

Until formal adoption in 2017, companies must disclose the anticipated effect the new standard will have on their financials, so knowing the magnitude of the change is a critical initial step. It could lead to adjustments in processes and affect how contracts are drafted. Moreover, companies need to have this type of data around now to decide whether to adopt the standard retrospectively (which will include 2015 financials) or prospectively (beginning January 2017).

The entire endeavor will go beyond the finance department. As we saw with the implementation of the previous revenue recognition standard, possibly business practices and certainly revenue accounting processes and systems will need to adapt to record revenue transactions correctly.

Simplifying matters for private companies: The good news for private companies is FASB’s Private Company Council (PCC), now a year into its Decision-Making Framework for determining the situations when private companies can use an accounting alternative, issued four PCC-consensus ASUs in 2014. With the goal of simplifying accounting and reporting for private companies, these new ASUs should reduce private companies’ cost of compliance.

      • 2014-02: allows private companies to evaluate goodwill impairment when a triggering event occurs rather than annually.
      • 2014-03: provides a simpler method of accounting for derivatives.
      • 2014-07: provides a simpler alternative than the variable interest entity (VIE) model for accounting for leases under common control.
      • 2014-18: hot off the FASB presses in time for Christmas, this ASU simplifies private company accounting for intangible assets acquired through a business combination.

Preparing for public-company life: Depending on your viewpoint, there has been a positive effect of the reduced reporting and SOX compliance provisions from the JOBS Act in the increased number of IPOs in 2014 (a 44% increase over the number of 2013 filings). And IPO and follow-on public market financing activity don’t seem to be tailing off so far as we start 2015, particularly in the Bay Area.

But before private companies rush to Wall Street, they need to remember that despite a one-year exemption from the requirement to have their auditors sign off on SOX, management must still include their own assertion regarding internal controls in SEC reports beginning with the second 10-K and will want to have effective internal controls way before then. The auditors will still want to get comfortable in knowing management is doing what they say they’re doing. (For more about braving the new world as a post-IPO business, see our recent intelligence report, Ensuring a smooth ride as a newly public company.)

Getting ready for the audit: Finally, the auditors also received their own flurry of new rules and warnings from the Public Company Accounting Oversight Board in 2014. Companies will end up feeling the effect as those changes trickle down, leading auditors to deepen their focus as they review certain accounting methods. The PCAOB has stated the new audit requirements and alerts were issued in response to insufficient audit procedures in areas that have a higher risk for misstatements and the incidence of deficiencies.

There is a new audit requirement surrounding transactions and financial relationships with related parties, including executive officers, as well as requirements that strengthen the auditing of significant unusual transactions.

Two new practice alerts were issued in the fourth quarter of 2014. One dealt with auditing revenue, specifically testing recognition and timing, evaluating the presentation (gross vs. net), internal controls, and the risk of fraud. Additionally, the alert addresses the application of audit sampling and analytic testing procedures.

The second alert reminds auditors about PCAOB standards related to auditing “going concern” with regard to the application of updated accounting and reporting guidance. The PCAOB’s agenda for 2015 includes a project to consider updating the auditing standard.

Companies will still need to be ready for the increased scrutiny by the auditors of their 2014 results as a result of the alert issued late in 2013 that seemed to sneak up on them as they went through audits last year. Be ready for testing of review controls, controls over system-generated data and reports, and management’s evaluation of identified control deficiencies.

We all recognize that the pace of change keeps accelerating and isn’t likely to slow down in 2015. Staying on top of what’s new and what applies to our specific situation requires quite a bit of focus. It is part of what makes your finance and accounting folks such valuable members of the team.

Julie Gilson is a senior consultant with RoseRyan and a CPA (inactive) with over 15 years working in finance and accounting with fast-moving public and private technology companies.

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New discontinued operations guidance de-clutters reporting

While large valuation acquisitions of entire companies (for example, Facebook acquiring WhatsApp for $19 billion) grab the headlines, the majority of the acquisitions are for just a division or segment of a business, and they have much smaller price tags and light media coverage.

Some of those deals are notable. Earlier this year, Nokia, which was once the dominant mobile handset maker in the world, sold its handset division to Microsoft for $7.5 billion. But most of them fall under the radar, justifiably. Each month in Silicon Valley, hundreds of high tech and biotech companies are making business and market decisions about when to sell off or close operations of a segment of their business. Reporting on these divested businesses is a time-consuming task that results in information that is often of little value to investors and can actually be confusing.

In response, the Financial Accounting Standards Board (FASB) recently updated guidance to strike a balance between the materiality of a discontinued operation and the details that companies need to provide about it. This revised standard (Accounting Standards Update No. 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity) is expected to result in fewer disposals being presented as discontinued operations. To qualify as a discontinued operation, a component or group of components must represent a “strategic shift” that has (or will have) a major effect on an entity’s operations and financial results. These can include the following:

  1. A major line of business
  2. A major geographical area
  3. A major equity method investment
  4. Other major parts of the entity

The guidance is to be applied prospectively to all new disposals of components and new classifications as held for sale beginning in 2015 for most entities, with early adoption allowed in 2014.

In the regular course of business, companies frequently evaluate how all their brands and segments align with their strategic plan. They may find some acquisitions that did not pan out, or segments or product lines that are being deemphasized or no longer fit with the strategy of the company. Closing or selling off such a division lets the company mitigate losses or accumulate additional capital that can be invested in its core businesses.

The same logic happens at your favorite neighborhood restaurant. Customers’ food preferences shift over time and items disappear off the menu when seasonal specials or improved offerings are available. Why keep an item on the menu that hardly anyone buys? Restaurant owners know they have to constantly improve operational efficiency and decrease their food costs associated with waste.

When companies in any industry give a contemplative eye to their own menu choices, so to speak, they may see how a paring down could lead to improved operations, lowered expenses, and greater efficiencies. The FASB’s new guidance uses the same definition for a component of an entity as before. That is, a component comprises operations and cash flows that can be clearly distinguished—operationally and for financial reporting purposes—from the rest of the entity. However, the new guidance requires that, in order to be reported, a disposal of a component represents a strategic shift that has or will have a major effect on an entity’s operations and financial results. This is a key distinction.

What this means is the new guidance provides a lighter financial-reporting burden when small divestitures occur. This is a rare “phew” finance teams rarely feel after seeing new accounting guidance.  Another significant improvement in the new guidance is the timing of disclosure—just because a company has continuing involvement with a disposed component doesn’t mean it has to put off reporting it as a discontinued operation. This change could result in easier negotiations for the company that is in the process of divesting a piece of its business but has a need to assist in the transition (for example, if the acquiring company still needs a manufacturing facility for a period of time).

Of course, companies should be mindful that new disclosures are required for disposals that don’t meet the new definition of a discontinued operation if they are material. And companies still have to give thoughtful consideration to what the FASB means by “strategic shift.” Does the company’s board view the disposal as indicative of an overhaul? Would giving it the heave-ho signify a big change in the direction for the company and be something investors would really want to know about? Would the marketplace care? Those are some key questions to ask. While the answers are going to vary from company to company, how any one company interprets the guidance should be consistent and well documented.

With the new guidance, companies can properly manage their business by shedding previously acquired companies and fine-tuning their operations without the clutter of reporting these activities if they are not material to their operations.

Steve Jackson, a member of the RoseRyan dream team, has expertise in the areas of revenue recognition, SOX, systems implementation, budgeting, financial analysis, and process improvements, among others. He has worked at public accounting firms and corporate finance departments for over 30 years.

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Revenue recognition: Are you in denial?

After more than a decade in the making, the FASB and the IASB finally issued new revenue recognition rules. Now if the boards needed that kind of a runway, how hard will it be for companies to implement? This is what management should be asking themselves.

But I get a sense that some are just in shock and aren’t asking the questions that need to get asked — maybe because they thought the guidance would never be issued or maybe because it’s just one more thing on the corporate plate right now. I get it. When anyone is in a state of shock, they tend to adopt a couple of go-to coping techniques — denial and procrastination. It’s been just over three months since the rules have been issued, and I have been witness to those coping techniques as companies battle implementation shock. What’s developed is a culmination of misconceptions, which we dispel below.

6 common misconceptions about the new rules

#1 The new rules don’t impact my business.
The new rules will apply to all entities that enter into contracts with customers, including long-term contracts and licenses. You cannot determine the impact until you truly evaluate each of your revenue models under the new guidance. Companies should also look ahead to how their business is growing and changing, and consider the new rules in connection with possible changes in their sales models between now and the adoption date. And, at the end of the day, even if your conclusion is “no impact,” you’ll also need to document your evaluation, vet it with your auditors, and update your financial statement disclosures and policy documentation so that they coincide with the new guidance.

#2 The implementation date is far away, so I can afford to wait.
While the standard is effective Q1 2017 for calendar-based public companies, the guidance does not allow for prospective adoption. You have some choices in terms of adoption methodology, but no matter what you decide you’ll still be looking back to 2016 and possibly 2015 if you choose full retrospective adoption…and 2015 is just around the corner. As a result, you will need to assess current contracts and those that commenced several years before the effective date. Then, when you begin to consider systems, processes, financial planning, investor communications, that date will no longer look so far off — especially when you know implementation duties will be in addition to your day job.

#3 Implementation of the new rules is just an accounting exercise.
So many people believe that it’s something that their accounting department will handle. Quite the contrary! Consider the following: debt covenants (treasury), sales incentives (HR), customer contracts (legal), investor communication (IR), systems (IT), and internal controls (internal audit). Companies big and small will need to think operationally where these rules are concerned. A successful implementation should be a collaborative effort across the organization.

#4 The standard only impacts the timing of revenue.
The fact is the new standard is comprehensive and changes the way we look at contracts with customers, the concept of delivery as well as many other aspects of the revenue process. For example, some of the collaboration revenue of life science companies may be excluded from the revenue guidance if the other party to the deal is not considered a “customer.” The new guidance also considers whether there is a financing component when an arrangement extends beyond one year. And any company opting for the modified retrospective adoption approach may have to record a cumulative effect of a change in accounting principle, which means it goes into the “black hole” of retained earnings, skipping the P&L, never to be seen again.

#5 My financial systems are savvy and can handle the rule changes.
With the complexity of contracts, there is no simple “flip-the-switch” scenario that can be employed. All types of revenue models will need to be evaluated. The new standard utilizes estimates and judgments, which can pose challenges in terms of automation. Companies may also want to look at additional reporting functionality to support their estimation process. And with all of this, internal control processes both in and around their system capabilities will need to be reviewed and updated.

#6 These changes always get delayed.
While some of us remember fondly the days when the internal controls part of SOX kept getting delayed, keep in mind that SOX was a U.S.compliance initiative. The new revenue rules, on the other hand, were developed in collaboration with the IASB in an effort to move closer to a single set of global accounting standards. The boards took great pains in developing the new standard and laying down the transition date so that reporting of revenue would be consistently applied on a global basis. So while companies may continue to lobby for postponement, this could result in nothing more than wishful thinking. Investors are going to want their companies to plan ahead — the “wait and see” approach will put delayers at high risk for financial misstatements and delayed filings.

In the face of a sweeping standard that could have extensive implications, it’s easy to understand why anyone would deploy coping strategies and try to look the other way. But as you can see from this list, there’s a lot to be done and only a certain amount of time to get it done right. The best approach is to tackle one step at a time. Start with assessing the impacts to your business — financial, operational and external. Then develop a plan. Knowing what needs to happen and how you can get there is certain to to take you away from the depths of denial to a clear path to compliance.

Kelley Wall leads RoseRyan’s Technical Accounting Group, which provides technical accounting and SEC expertise to public and private companies on complex accounting matters and implementation of new accounting pronouncements.

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