It’s always healthy to take a fresh look at your disclosures and discussions in your annual reports. Situations change, boilerplate language doesn’t always cut it, and changes in accounting policies make it a necessity. This year, more than ever, several drivers make such a review a can’t-miss effort.

A number of new accounting standards are coming down the pike that will significantly change the information you provide. And investors and analysts want to understand now how these accounting changes will impact your financial statements and how you’ll report what is happening in your business.

So, we’re highlighting a few areas to focus on this reporting season, and we’re giving you a head-start on what you may want your related disclosures to say.

The new revenue standard

Arguably, this is the biggest change in accounting we will see in our lifetime—a generational change. Anticipating the shifts companies will be making in how they recognize revenue in the years ahead, the Securities and Exchange Commission has high expectations for your next round of disclosures. They’ll be looking out for the effects the new standard will have on your accounting through what’s commonly known as SAB 74 disclosures.

The SEC said from the start that they expect these disclosures to evolve as implementations progress. The SEC Corp Fin staff is now saying that they are done waiting, and it is no longer acceptable to limit your disclosures to boilerplate “we are still evaluating” language in your calendar Q1 2017 filings (10-Ks, 10-Qs). They upped their scrutiny in this area with Q3 filings and expect to see more robust disclosures for year-end.

Companies that don’t meet these expectations will likely receive a comment letter asking for more information. The SEC enforcement staff has even gone so far to say that they will pursue enforcement actions if SAB 74 disclosures are not robust enough.

So, what should you be saying?

In your footnote disclosures, you should assess the expected impact of the new revenue standard or, at a minimum, provide directional guidance in the areas that are relevant to your business. See below for some examples:

  • The timing of revenue recognition.“The Company expects revenue recognized on a cash basis today to be recognized earlier under the new standard.”
  • How revenue allocations among multiple deliverables will change.“The Company expects the revenue allocation between software licenses, maintenance, and other services to change, since the estimated consideration will be allocated between each performance obligation based on relative selling prices rather than using a residual method for software licenses under the current guidance.”
  • The impact of variable consideration estimates, such as contingent payments, customer discounts, and price protection rebates.“The Company expects to include sales-based milestone payments that are probable of payment in our estimates of variable consideration, resulting in more revenue recognized as associated performance obligations are delivered rather than waiting for the milestone payment to be paid.”
  • The impact of shifting from a sell-through to sell-in revenue recognition model when estimating returns.
  • Changes in the timing of revenue recognition from separating financing components from contract consideration.“The Company expects contracts with extended payment terms to be recognized earlier after separating a financing component from the consideration.”
  • The capitalization of costs that are incremental to each contract and recognition concurrent with the associated revenue.
  • Quantification of the overall impact of the standard.

Have you done your diligence with the new standard and believe it won’t make much of a difference? If you expect the impact of adoption to be immaterial to your financial statements, you still need to address it and explain your reasoning. Here’s an example of language you could use:

  • “The Company expects the impact of adoption to be insignificant to its financial statements, since its contracts are simple with only one performance obligation delivered at a point in time for a fixed price. The only new accounting element will be the capitalization of costs incremental to each contract and recognition concurrent with revenue, which is accrued when the order is placed and recognized when the goods are delivered.”

You should also include facts about your implementation of the new standard:

  • When you expect to adopt and your planned transition method.“The Company intends to adopt the new revenue standard as of January 1, 2018, with a modified retrospective transition approach.”
  • The status of your implementation.“The Company has completed our evaluation of the changes in accounting for representative transactions under the new guidance.”
  • Significant areas you still need to address and when you expect to address them. “The next areas to address in the implementation are: (i) establishing relative selling prices for each performance obligation, (ii) assessing the accounting impact to the financial statements, (iii) developing tools to monitor the additional information needed, (iv) preparing the accounting entries for adoption, and (v) writing supplemental footnote disclosures. The Company expects to complete these efforts by the fourth quarter of 2017.”

In your MD&A discussions about the new revenue standard, you should emphasize the future impact of the new accounting treatment:

  • Material changes and trends: Under the new standard, for instance, do you expect more variability because revenue will be recognized earlier, or will you have to make significant estimates?
  • Financial and non-financial impacts: For example, changes in the balance sheet for contract assets and liabilities may affect key financial ratios that are embedded in debt covenant requirements.
  • Significant estimates and judgments: Consider estimates related to variable consideration and the constraint on variable consideration, including returns, price protection rebates, and cash discounts or the probability of milestone payments. Another example is the estimation of standalone selling prices and the allocation of discounts and variable consideration in allocating the transaction price.

Other areas to refresh

While the new revenue standard may be the most significant change that you need to address in your financials this year, a few other areas also warrant your attention.

Management’s assessment of going concern

You are now required to perform your own assessment as to whether there is substantial doubt about your company’s ability to continue as a going concern within one year after the date you’ll be issuing your financial statements (so if you file your 10-K in March 2017, you would need to assess your ability to continue as a going concern through March 2018).

If conditions or events raise substantial doubt about your ability to meet your obligations, you need to consider management’s plans to mitigate those doubts if (1) it is probable you can implement those plans and (2) those plans will mitigate the doubt.

Substantial doubt about the company’s ability to continue as a going concern will require expanded footnote disclosures that cover the period through 12 months from the date of financial statement issuance (instead of prior disclosures that focused on 12 months from the balance sheet date).

SAB 74 disclosures for other new standards

Don’t forget, you also have SAB 74 disclosure requirements for other new accounting standards, including:

  • Leases, which is scheduled for adoption in 2019 for public companies and 2020 for private companies. Example language beyond standard boilerplate might include:“The Company’s leases are limited to operating leases for the Company’s corporate headquarters and regional sales offices. Management is currently evaluating the impact of adoption. While management cannot yet estimate the amounts by which its financial statements will be affected, the Company has identified the following changes. The Company expects the recognition of expense to be similar to current guidance under the new standard. And there will be a significant change in the balance sheet due to the recognition of Right of Use Assets and corresponding Lease Liability. The Company plans to adopt the new Leases standard effective January 1, 2019, following a modified retrospective transition method.”An item to consider highlighting in your MD&A discussions would be any expected impact on debt covenant financial ratios caused by leases coming onto the balance sheet.

During this refresh process, keep at the top of your mind the changes that have caught your attention or caused you concern. Provide enough information to investors and analysts to help them understand the significant impacts of new standards on your business.

No one likes to be at the bleeding edge by expanding disclosures before they have to, but don’t be left behind. Expect that across the board, companies will be sharing expanded disclosures about new accounting standards this 10-K filing season—particularly related to the new revenue standard.

You will be the odd man out if you don’t make your own disclosures more robust.

The exact language you use for your disclosures depends on your facts and circumstances, of course. Feel free to contact us if you have any questions about the accounting changes ahead and how to deal with them.

Diana Gilbert, who heads our Technical Accounting Group, has been a member of the RoseRyan dream team since 2008 and has 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.