I recently took a call at our office from a prospective client who was in the process of implementing the new revenue recognition standard, ASC 606 / IFRS 15 Revenue from Contracts with Customers. After explaining our services and directing them to our numerous blog posts and online training on the topic, the conversation led to their transition efforts. Little did I know that our conversation would lead me to uncovering an implementation issue that was previously unknown to me.
From what I heard, this prospective client indicated they were going to take a sample of their various revenue contracts, determine the difference, if any, between the new and old standards, and use the information to determine the transition adjustment needed upon adoption of ASC 606. I chuckled and immediately said, “What? Good luck getting your auditors and the SEC to buy off on that!” The conversation continued a bit longer, but was noticeably uncomfortable after that. Guess I should have been a bit more restrained. Although the truth may set you free, it doesn’t necessarily always win you clients!
The next day I co-facilitated a webinar with Softrax and provided an overview of my conversation a day earlier, insinuating, again with a chuckle, that such an approach would never fly. One of the participants wrote in a question about sampling revenue contracts. It read:
The presenter was laughing earlier about the sample approach. Is the approach of taking a representative sample of contracts within each revenue stream not acceptable? Should a company plan to review each one of its contracts? Could a company set a materiality threshold? How is the portfolio approach affected by this?
After reading the participant’s question, I felt bad that I was not able to answer it during the presentation because it was only sent after the webinar had concluded. However, I felt I needed a bit more information before responding, so I reached out to an audit partner with a Big 4 firm with the following email (in part):
I was wondering if you could talk to me about an ASC 606 implementation issue. The issue relates to sampling revenue contracts during implementation. I certainly understand taking a sample to assess the impact, but I didn’t think you could sample and then extrapolate for the actual transition entry. I just want to make sure I am not becoming all theory and not understanding how things work in the “real world.”
I spoke to a couple of revenue people in our head office and they have never heard of that approach. None of us think that would fly. Happy to discuss, though. It gets an “A” for creativity!
Drop mic! I was right. However, I couldn’t help but feel I was missing something. So, I did what all geeky accountants do, I started researching!
It’s understandable why companies would want to take a shortcut. ASC 606 is effective for calendar-year end public business entities on January 1, 2018, with a one year delay for other entities. IFRS 15 is effective for all entities in a matter of a few months and, based on recent surveys, companies are way behind. Time is running out!
As I referenced in my email, I certainly understand using a sample approach during the ASSESSMENT PHASE in order to understand the impact, if any, of implementing the new standard. After gaining an understanding of their various revenue streams and categorizing them accordingly, a company would then take a representative sample of the contracts to (a) understand the issues and impacts of the new standard and (b) ensure they are properly categorized.
This step is extremely important and, ideally, should have been done many months ago. Why? Because examining individual contracts and running them through the new 5-step approach is the only way to assess the true impact of the new standard. And this takes time!
According to a Deloitte paper Revenue recognition: Pain points beyond accounting, “the new standard requires many companies to work through new levels of materiality and greater depths of analysis.”
This knowledge should then be used to improve processes, systems, and controls in the IMPLEMENTATION PHASE. Once these are in place and functioning, all current revenue contracts impacted on transition (and future contracts) would be processed by the new systems. It is my understanding that a sample cannot be used in this phase.
The Deloitte paper states, “Complying with the new standard will likely come at a cost. Some of the price tag may be related to reconfiguring IT systems or hiring third-party resources, but the main cost will likely be the time involved. The vast majority of the effort will probably be associated with the accounting analysis and fully understanding what changes need to be made.”
What about the portfolio approach? ASC 606-10-10-4 states:
This guidance specifies the accounting for an individual contract with a customer. However, as a practical expedient, an entity may apply this guidance to a portfolio of contracts (or performance obligations) with similar characteristics if the entity reasonably expects that the effects on the financial statements of applying this guidance to the portfolio would not differ materially from applying this guidance to the individual contracts (or performance obligations) within that portfolio. When accounting for a portfolio, an entity shall use estimates and assumptions that reflect the size and composition of the portfolio.
So, it appears there may be some relief to applying the guidance on a contract-by-contract basis. However, that’s it. One paragraph in all of ASC 606. I guess I know a topic for a future blog post – using the portfolio approach as a practical expedient!
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