FASB Seeking a Lot of Input

The Financial Accounting Standards Board (FASB) is seeking a lot of input, or is that input a lot, given the number of recently issued documents. In the past few weeks, FASB issued exposure drafts on:

  • Identifiable Intangible Assets and Subsequent Accounting for Goodwill;
  • Changing the interactions between Topic 321 (Investments – Equity Securities), Topic 323 (Investments – Equity Method and Joint Ventures) and Topic 815 (Derivatives and Hedging);
  • Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity;
  • Changing effective dates for standards on Credit Losses, Derivatives and Hedging, Leases, and Insurance;
  • Facilitation of the Effects of Reference Rate Reform on Financial Reporting.

The AICPA Financial Reporting Executive Committee spent time last week discussing potential responses to the Goodwill invitation to comment and the Convertible Instruments exposure draft. The first question FASB asked about goodwill was “what is goodwill or in your experience, what does goodwill represent?” At first, that question seems a bit strange, but as we continued our discussion, it became very clear that thoughts about potential amortization and how to handle impairment testing were significantly influenced by what each member perceived goodwill to be. I would venture to guess that grouping responses based on the answer to the first question will result in responses with similar answers to the remainder of the questions. Therefore, I am very interested in what the members of FASB think goodwill is, because ultimately that will most likely drive any changes to accounting for goodwill.

As we continued our discussions on convertible debt, I think we were getting a little punchy near the end when we started to ask questions like how to determine if it was more likely than not that it was probable something remote would not happen. If you laughed at that, you must be a CPA.

Preparers and auditors for private companies should be very interested in the proposals around changing effective dates. Not only does the proposal delay the implementation of four specific standards, the exposure draft also contains a revised framework that would place a two-year delay between the effective dates for public and private companies implementing significant new standards.

The justification is that for a private company to be able to garner learnings on implementing the standards at public companies, then a one-year delay is simply not enough. With only a one-year delay, the private companies already need to be accounting for transactions under new standards before public companies ever issue a complete set of annual financials under such standards. A two-year delay would provide at least several months between initial public company reporting and requiring a private company to follow a significant new standard.

While none of these proposals are as significant a change as revenue, leasing or credit losses, the number of changes do add up. If you work at or with public companies, it is no time to let up, and if you are focused on private companies, here are a few more changes to focus on in addition to everything else on your plate. Good luck to all!

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Lessons on the Time Value of Money

A recent article by CNBC really brought home the time value of money and the impacts of rate of return on saving for retirement. Assuming an 8% rate of return, the monthly amount a person needed to save to have $1 million at age 65 changed dramatically with age:

  • Starting at 25 $284.55/month
  • Starting at 30 $433.06/month
  • Starting at 40 $1,044.53/month

I know some people will think those amounts are not obtainable, but $284.55 represents 10% of the monthly salary of someone making only $34,146 per year and that is before any employer match. If the employer matches contributions to a retirement plan, the required salary is even lower.

The amount also changed dramatically depending on the rate of return expected:

  • 8% return (starting at 25) $284.55/month
  • 6% return (starting at 25) $499.64/month
  • 4% return (starting at 25) $843.23/month

Some people tend to freak out when the stock market takes a downturn and we haven’t seen a sustained downturn since the last decade, but the numbers above show that you can’t put your money only in safe investments like bonds and treasuries. The return is not enough to get you where you need to go. And the younger you are, the more ability you will have to recover any losses because you are so long from retirement.

So, what does all this mean? While I agree with Dave Ramsey that doing smart things with money is 80% about behavior and only 20% about the math, and it is generally more important to change behavior through focusing on paying down debt first, if the debt can’t be paid off in a couple of years, the math can start to work against you in the worst way. Here are some very simple tips.

  • Start putting money away for retirement early; shoot for 10% of your salary. If you can’t get there right away, put in as much as you can and raise it every time you get a pay raise – you won’t miss what you never had.
  • Try hard to get your employer match, if available. You can count the employer match in getting to that magic 10% level (to get to that $1 million by age 65) and you won’t have 10% coming out of your check. Not getting the match is like telling your employer you really don’t want all your salary. Would any sane person really do that?
  • Don’t be too conservative in your investments – especially if you are young. Being too conservative is much more likely to reduce your chance of getting that $1 million than a periodic (and they will occur) market downturn.

As crazy as it sounds, there is no reason we could not have millions of millionaire millennials by the time they retire if they would just take notice of the time value of money. Talk about being able to change the world – wow!


Let’s Go To The Movies

Looking at my past few blogs, I realized I got into a rut of focusing on accounting standards. It’s time for a switch to something a little less heavy and what better time of the year than the end of the summer movie season to talk about some fun movies that included an accounting bent.

“Look Who’s Talking” – Do you remember Mollie’s (played by Kirstie Alley) job – yup, she was a CPA. And how many of us have wanted to wipe a dirty diaper on a client’s desk who was being ridiculous in their demands? Well, Mollie did it! Ahhh! The satisfaction.

“Schindler’s List” – While a movie about the Holocaust can hardly be inspiring, at least the accountant (played by Ben Kingsley) found a way to use the system to overcome the worst of the evil and save over 1,100 Jews by helping get them deemed as “workers essential for production.”

“The Untouchables” – All of the shooting and action couldn’t hide the fact that it was the accountants putting together a case on tax evasion that finally put Al Capone (played by Robert Di Niro) away. As the saying goes, nothing is certain but death and taxes.

“Catch Me If You Can” – Bank fraud anyone? Frank Abagnale (played by Leonardo DiCaprio) outsmarts everybody until he finally goes too far and gets caught. Two points. Somehow Frank studies like crazy for two weeks and passes the bar exam. I’d like to see someone do that on the CPA exam. And in the end, Frank turns good and develops many of the anti-fraud mechanisms banks used for decades to thwart fraudsters. As I’ve told people for years, in order to audit for fraud, we all have to think like a fraudster. Frank absolutely proves that.

“Shawshank Redemption” – While Andy Dufresne (played by Tim Robbins) was technically a banker and not an accountant, it was his skills as an accountant that made him indispensable to the warden in cleaning up that river of dirty money. Not only does he help get the bad guys in the end, he helps a lot of other people along the way – just like many of my colleagues in the profession.

There are many more movies with accountants – “Ghostbusters,” “Midnight Run” and “The Accountant” to name a few. One common theme is that the accountant rarely, if ever, is the bad guy. Lawyers, businessmen, politicians and everyone else are star bad guys in movies, but never the accountants. We just do our job and, in the end, help the public. At least Hollywood got that one thing right!


Revenue Recognition

While the Financial Accounting Standards Board (FASB) recently proposed delaying the implementation of four standards for private companies, including leases and credit losses, private companies are in the midst of the adoption year for revenue recognition and there is no relief coming from the need to follow the new standard in 2019 financial statements. I recently provided some guidance to a fellow TXCPA member on TXCPA Exchange, which is a forum for knowledge exchange with your professional colleagues. The initial question was about recognizing revenue in a contract that included professional services and software. Excerpts on our exchange are as follows.

If the product has to have professional services in order to function, then the services and license would not be distinct. Is that correct?

No. The question of distinct is not based on if the license would have to have professional services to be distinct. If the customer could get those services from a different vendor, the license would still be distinct even if professional services (from some vendor) were required.

Is distinction considered on a contract-by-contract basis or by product?

Technically, you look at each contract separately. There are two factors to consider when determining if a product or service is distinct:

  1. Can the customer benefit from the product or service on its own or together with resources that are readily available to the customer?
  2. Is the entities promise separately identifiable from other promises in the contract – that is, it is distinct in the context of the contract?

The first test can really be done at the product level. Either the product, service or software license is “capable” of being distinct; remember, this doesn’t mean the product, service or license is not dependent on other items. It just means that the customer can get those other items from other sources.

The second test is a contract-by-contract test, although in reality most businesses have standard contracts or at least generally standard formats, so often the same conclusion can be reached for all “similar contracts.” When it comes to software and services, a key factor to consider is the 606-10-25-21 b. factor, which indicates that a promise is separately identifiable. The factor is:

“The good or service does not significantly modify or customize another good or service promised in the contract.”

If the professional services are changing the underlying code of the licensed software, then I think the professional services do “significantly modify or customize” the software, so the services are not separately identifiable. On the other hand, if those services are standard configuration work, they would likely be considered a separate, distinct service.

If I have a $500k contract, and the professional services are worth $200k, would it be appropriate to then recognize the $200k professional services as % of completion or milestone?

Probably. To recognize revenue over time (that is what is implied by % of completion or milestone), you must meet one of three criteria:

  1. The customer simultaneously receives and consumes the benefits provided by the seller.
  2. The seller creates or enhances an asset that the customer controls as the asset is created or enhanced.
  3. The seller does not create an asset with an alternative use to the customer and the seller has an enforceable right to payment for performance completed to date.

Professional service revenue, if recognized over time, generally falls to the third criteria above. Think of the first criteria for things like cable TV service. The second criteria is generally about building a building. Because many professional services do not result in the creation of an asset, recognition over time falls to the third criteria. (An exception to this is professional services where the output is a software program or website, in which case an asset is being created. In that case, you do have to consider whether the customer is taking control of the asset as it is being created.)

If I have a $500k contract and the software is worth $300k, would it be appropriate to recognize the $300k ratably over the license term?

No (most likely). This was one of the big changes in the new revenue standard. Once you turn over the software license, even if it is for multiple years, there is nothing more for the seller to provide to the customer, so the entire amount of the revenue for the software licenses is recognized at a point in time “upfront.” If the license also includes rights to future upgrades, those future upgrades are considered a distinct performance obligation and should be separated from the software license and valued distinctly, with revenue recognized as those upgrades are provided. But the portion of revenue allocated to the initial licenses is recognized immediately upon the license being available to the customer for use.

I also want to note that software as a service, where a license and “code” is not provided to the customer, but instead the customer accesses the software on the seller provided platform, is different from selling a software license and must be evaluated differently for when to recognize the revenue, but I won’t get into that here, because that does not seem to be the question at hand.


Tax Accounting and Disclosures

In last week’s blog, I mentioned three recent proposals from the Financial Accounting Standards Board (FASB), but only discussed the one on disclosure improvements in depth. This week, I’m going to go back and talk a little more about the proposals on income tax accounting and disclosures.

The proposal on accounting for income taxes mainly focused on eliminating exceptions to the general rules for accounting for income taxes. By eliminating limited use exceptions, the accounting should become easier, with fewer “gotchas” for unusual circumstances. One of the proposals was to clarify that franchise and other “non-income taxes” (by name) that are effectively based on income should follow the income tax accounting requirements, at least for the portion of the tax that equates to the amount that is computed based on income. This could potentially impact the accounting for the Texas business margin tax, so CPAs with Texas business clients should pay particular attention to how the final standard is worded.

The proposal on income tax disclosures covered a lot of ground and included eliminating some disclosures. Don’t get too excited though; different disclosures were proposed to be added. In the end, I think disclosures net/net will expand rather than contract. One of the proposals is to include a five-year table of the reversals of tax liabilities. Having to show the reversals by year will be a new level of detail that many preparers don’t currently calculate, even for internal purposes. This disclosure could also be a challenge for auditors to get comfortable with, because it will be based on many estimates and future information.

Another auditor nightmare could occur related to the disclosure on pretax income from continuing operations before intra-entity eliminations. The term intra-entity eliminations has not been previously defined in generally accepted accounting principles (GAAP) and, because the number will involve multiple entities and potentially not tie to any amount in the presented financial statements, auditors might have difficulty coming to terms with how to exactly audit such an amount.

TXCPA responded on your behalf to both proposals. If you would like to learn a little more about both proposals and TXCPA’s responses, the response on Income Tax Disclosures can be found here, while the response on Income Tax Accounting can be found here.

 


Improvements

The Financial Accounting Standards Board (FASB) has been busy lately issuing exposure drafts on disclosure improvements, income tax disclosures and income tax accounting. You note that I said disclosure improvements, not simplification and especially not reduction for the first exposure draft. The exposure draft was in response to a Securities and Exchange Commission (SEC) request to consider incorporating several SEC mandated disclosures in generally accepted accounting principles (GAAP). Most of the changes are minor and will not require any significant additional work by preparers, but there are a few you might want to take a look at a little closer.

The first is a requirement to disclose the calculation method for dilutive securities in determining earning per share (EPS). GAAP requires preparers to calculate the dilutive effect using two methods and then use the method that results in the lowest EPS. This means that a company might be switching methods from quarter to quarter to comply with GAAP.

The proposal is for companies to disclose the specific method used each quarter. Making the disclosure does not really require any additional work, but to the uninitiated investor seeing a company change calculation methods each quarter might raise questions about “shenanigans” going on at the company when, in fact, the company is simply following a GAAP requirement. When companies have a choice in methods, it makes perfect sense to disclose that choice. When companies are required to use a specific method each quarter, even if that method changes, disclosing the change only serves to confuse rather than inform investors.

The second proposal is to require that prior financial information – think income statement and balance sheet – for acquired companies be included in the footnotes to a newly consolidated company’s audited financial statements. The practicality of this requirement could be problematic from an audit perspective. If a predecessor auditor existed, there are potential concerns about how to incorporate that work into the successor auditor opinion, but at least a path on how to handle those situations exists within the auditing standards.

The bigger problem comes from cases where the acquired entity was not audited. I know that would be rare to nonexistent for material public company acquisitions, but this is a change in GAAP and a private company acquiring an unaudited entity would have to comply with the disclosure requirement or get an adverse opinion. It is possible that a private entity may not even be able to comply with the disclosure requirement if they wanted to. An auditor may not be able to audit certain amounts – think inventory or cost of goods sold – that happened in the past. If those numbers can’t be audited, then a clean opinion may be impossible to obtain. Is that really a proper result for private companies acquiring small, but material unaudited entities?

Finally, an overall concern is the migration of public company reporting requirements from the SEC to reporting requirements for all companies, whether public or private. We already have a strain between the requirements in GAAP that is focused on public companies and the needs of private company financial statement preparers and users. While a majority of the changes proposed seemed appropriately applicable to both, the precedent-setting aspect of a public company focused SEC dictating GAAP used by private companies is something we all need to recognize as a path fraught with pitfalls that requires an extra layer of deliberation to make sure GAAP is serving all constituents, not just the fewer larger public companies.


Changing

TXCPA members and the Board of Directors recently met in steamy New Orleans to set the path for the profession in Texas. An overall theme that emerged at the meeting was change. As noted by our keynote speaker, Barry Melancon, CEO of AICPA, change will never be slower than it is today. You read that right. Change will never be SLOWER.

What does that mean for the profession? One of the things it means is that we won’t be able to make a big push and change the CPA Exam, change the CPA licensure requirements, change how the profession is presented to potential new colleagues, change the audit model and change the reporting model, and then take a deep breath and sit back for the next decade.

Those who sit still will be passed by or disrupted. Ask Sears, Kodak and many other businesses that were once leaders and even had the keys to the future – Kodak invented digital photography and Sears was into home delivery before it was cool – if taking time to get to the future is fast enough. Those businesses, for some reason, paused and now they are irrelevant.

We can’t simply think about what it means to audit a business that employs blockchain and artificial intelligence. We need to rethink how those technologies impact the whole audit process at its core. Does blockchain make confirmations irrelevant? Does artificial intelligence allow constant population testing where never possible before?

When it comes to tax work, are tax returns the feature product of our work as many view them today or will tax returns become a byproduct of work around life planning for individuals? These are some of the challenges the Board started to discuss at the meeting in New Orleans. We certainly won’t come up with all the answers, but TXCPA is working to provide its members with ideas and connections to discuss the future, so members of the profession stay relevant to your current and future clients.