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!
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:
- Can the customer benefit from the product or service on its own or together with resources that are readily available to the customer?
- 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:
- The customer simultaneously receives and consumes the benefits provided by the seller.
- The seller creates or enhances an asset that the customer controls as the asset is created or enhanced.
- 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.
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.
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.
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.
Being good is simply not good enough. The first question I hear from many people when seeking advice is what do I need to do better? The problem with that question is getting better starts from looking at areas of weakness that need to be improved. If an area of weakness is a fatal flaw, something that will truly hinder your career, then by all means, you need to work on that area. But once you have eliminated career limiting flaws, what next?
Too often people try to create a breadth of skills they are good at. This is kind of like investing in an index fund rather than individual stocks. You won’t lose big, but you won’t do better than average either. In investing, this is a great strategy, but in career building such a plan may not be the best. Instead, people should think about finding a few things they could be great at doing. Think about it – who is more likely to get noticed, someone who is a solid hard worker or someone who delivers something special?
If you’re honest with yourself, the answer is someone special will get noticed first. Then people will look at the person who does something special and, if they are good enough at everything else, give that person the opportunity for the next project or promotion. My “special” is accounting policy and standards. If you ask people who know me just a little, the first thing they will comment on is that I have a unique ability to understand how transactions should be accounted for under our standards and rules. Once people notice me for that talent, they look a little deeper and realize I’m a pretty good manager, supervisor and leader, too. (Yes, those are different skills.)
The point is that without the initial recognition because of my special skills in one area, the rest of my “good” skills would never be recognized. As you move up the ladder in your organizations, it gets harder and harder to show how you’re different. Everyone is good (well, above average). The question is, how do you shine when everyone is talented? I think the answer is to pick something you’re (very) good at and become great at it. Being great at something is what will continue to get you noticed, after which, you can then show off all the other things you are good at.
What are you, or can become, great at? That’s the question you need to answer to get noticed and accelerate your career path.
I know we all became or are becoming CPAs because we like numbers not words. Well, how did that work out for all of you? Looking at the last week, I probably read or wrote 1,000 words for every number I entered on a spreadsheet. The reality is that our life as CPAs is buried in words, including reading contracts, leases, marketing proposals, tax regulations and accounting standards. The resulting work of taking all those words and determining the resulting numbers to put in the accounting systems can be easy or difficult depending on the precision of the questions asked about the documents we read.
Let’s take a recent example that had lots of people talking, the end of Game of Thrones. The big question was who was going to be King or Queen of Westeros at the end. The easy answer is that the king was Bran the Broken of House Stark. Everyone who said it would be Bran was right … well, not so fast. That depends on what question was asked.
If the question asked was who would sit on the Iron Throne at the end, maybe the answer should be no one. I mean, the throne was melted out of existence by Drogon the Dragon, so no one can sit on it, right?
If the question was who will rule the Seven Kingdoms, the answer once again maybe no one, because one Kingdom decided not to bend the knee and be independent at the end.
If the question was which house will rule the Seven Kingdoms, then the answer may be House Stark, because even though one Kingdom decided to be independent, it is also ruled by a member of House Stark, Sansa Stark.
There is a tired old joke about a series of accountants being asked what two plus two is, and the one who gets hired is the one who says what do you want it to be? Maybe we’ve been missing the moral of that joke all these years. Maybe the real point of the joke is that answers depend on the questions asked