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Latest revenue recognition guidance: throw out the recipe box

It’s been more than a decade in the making, but the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) are in the final throes of issuing a global revenue recognition standard to replace all others, including the mirage of industry-specific guidance the United States follows today. The new guidance is “principles-based,” so you’re not going to find specific rules or instructions—no more recipes for that special occasion. Instead, the new guidance is about substance, judgment and transparency.

The core principle is “recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” The FASB provides a five-step process to achieve this: (1) identify the contract with the customer, (2) identify the separate performance obligations, (3) determine the transaction price, (4) allocate the transaction price and (5) recognize revenue when the performance obligation is satisfied. The objective: enable companies to recognize revenue based on the substance of the transaction with the customer, while providing enough guidance to help ensure consistency with other companies. This is a difficult balance, as evidenced by how long this guidance has been in the cooker.

Lots of judgment required, but no measuring cup
Principles-based guidance requires judgment—lots of judgment! Have you entered into a new contract with a customer or modified an existing contract? Which of the performance obligations can or should be separated? Not all will qualify. Special terms and pricing arrangements can create variability in the amount of revenue a company is entitled to receive, and probability has to be assessed. Companies will need to estimate the stand-alone selling price for each performance obligation—that means you too, software companies. Performance obligations are satisfied when control is transferred to the customer, but for companies that provide services, this is more complicated—services don’t come in a box, so delivery is more theoretical and an appropriate measure of progress needs to be evaluated. Finally, revenue has to be “reasonably assured” to be recognized. That’s a qualitative threshold—no measuring cup required.

Disclosure is hot: share your secret sauce
And it should come as no surprise that where significant judgment is applied in accounting, especially for revenue, transparent disclosure is vital to understanding the financial statements. At the bottom of the statements the footnote should read, “See accompanying notes to the financial statements … seriously.” The level of disclosure continues to be a hot topic as the guidance makes its way through the comment process, and the latest exposure draft also includes enhancements to interim disclosures as well. Companies will need to disclose their secret sauce, providing qualitative disclosures, including a description of the judgments involved, and also quantitative disclosures, which may require additional financial system reporting requirements. While it may be more difficult for the SEC to question the judgment applied in recognizing revenue, you can bet that they will be all over companies that do not provide adequate disclosures. For companies currently employing a “less is more” disclosure process, this will be a dramatic change.

Want to see what’s cooking? Download a PDF of the latest exposure draft from the FASB website. Comments are due March 13, 2012, and a final standard is expected in the second half of 2012. The proposed effective date is 2015.

Think you have time to prepare?
Think again. In its proposal stage, the guidance requires full retrospective application, so public companies presenting three years of financial statements will also have to present 2013 and 2014 for comparative purposes. Don’t let this overwhelm you—give us a call to see how RoseRyan can help make the transition easier.

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IASB vs. FASB: What’s the difference?

The SEC is expected to issue a recommendation before the end of the year that may require publicly held companies to adopt international accounting standards issued by the International Accounting Standards Board (IASB). If this happens, it’s not clear how the IASB and the Financial Accounting Standards Board (FASB) would work together to support and issue future international accounting standards. In a recent speech, FASB chair Leslie F. Seidman stated that FASB “should continue to have a strong role in influencing what goes on the international agenda, the process by which these issues are analyzed, the level of implementation guidance provided, and the outreach that is conducted in the United States.” Although IASB and FASB are similar—both establish and improve standards of financial accounting and reporting—there are some distinct differences.

The FASB is part of the Financial Accounting Foundation (FAF), which is overseen by a board of trustees, and is independent of all businesses and professional organizations. It is funded by fees paid by issuers. The IASB is overseen by trustees as well, but it is accountable to a Monitoring Board of capital market authorities. It also is funded by market participants, but is funded by relevant regulatory authorities as well.

The FASB currently has seven board members appointed by FAF’s board of trustees, and each may serve up to two five-year terms. The IASB currently has 15 members appointed by trustees through an open and rigorous process that includes advertising vacancies and consulting relevant organizations.

The biggest difference: post-implementation
Probably the most distinct difference between the two organizations lies in the area of post-implementation of standards. The FASB has no formal process for reviewing the effect of a newly issued accounting standard. Post-implementation issues can be dealt with through an SEC action (Staff Accounting Bulletin) or an American Institute of Certified Public Accountants action (EITF), which may result in an update to the Code. The IASB, on the other hand, has a formal, two-year post-implementation review on all standards it issues.

Last, the operating budgets for 2011 for these two organizations are vastly different. For the FASB, its budget is $53.3 million USD. For the IASB, its budget is £20.1 million (approximately $31.4 million). These amounts are incongruent given the relative size of each organization’s board.

What does it all mean?
We don’t really know how the move to international standards, with the attendant IASB oversight, will affect U.S. public companies. The IASB does have the same purpose as the FASB, but I would note the IASB has more structure when it comes to evaluating new accounting pronouncements. I think this additional structure is something public companies would welcome. It also seems that the IASB is able to operate in a streamlined manner!

 

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Survey benchmarking Bay Area start-up environment reflects RoseRyan client experience

The Bay Area Council Economic Institute has just released the results of its survey that benchmarks the Bay Area environment for young companies and entrepreneur-led start-ups. The Council’s 300+ members are a “who’s who” of Silicon Valley; I was pleased to be selected as one of the partners who contributed to the study.

Although there has been improvement in the local economy over the previous year, the survey shows there are still challenges. This is consistent with RoseRyan’s experience in the marketplace. Our clients are still having a tough time raising capital, regulations are still difficult to navigate, and other geographic areas are competing for business, but I am still optimistic in this region’s ability to adapt and innovate at a great pace.

I’ve compared some of the key findings to RoseRyan’s experiences:

Listing regulations and requirements do not discourage companies from seeking public listings: Only 16 percent of respondents agree. This is key as clients usually are not prepared to handle all of the main components of preparing their S-1s and SOX requirements after an IPO.

The government has developed tax incentives to increase the amount of research and development. 36 percent disagree and 28 percent are neutral. Tax incentives play a smaller role here than other parts of the world. Most companies, like most of our clients, do not rely on government subsidies but are certainly aware of available grants and tax incentives.

Compliance with government regulations does not unfairly burden new and growing firms: 31% disagree, which is much lower than other parts of the world. This is consistent with many of our clients’ experience. They still have to deal with a labyrinth of regulations in California which are slowly getting less cumbersome.

Government programs provide high-quality services to new and growing firms: 12% agree. Unfortunately, there does not appear to be any faith in government programs. Many of my clients feel that government support is a bonus.

Most entrepreneurs personally know one or more private individual investors (i.e., “angels”): 43% agree. Most of RoseRyan’s clients are cognizant of the “start up” ecosystem of investors.  They understand the ebb and flow of the markets based on the overall economy.

Stock options are considered a positive source of compensation. 84 percent agree.  This is consistent with our business, and we expect stock options to be a strong motivator for attracting and retaining employees.

Benchmarking the Bay Area’s Environment for Entrepreneur-Led Start-ups provides many other interesting insights. You can learn more about the Bay Area Council on their website.

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