I have always felt like the ideal of one set of global accounting standards made sense. If business is global and accounting is the language of business, we need one language, not several different ones. The ideal of a single set of global standards took on a hard reality with the creation of the IASB, the adoption by all of Europe as its single source of accounting standards and the famous or infamous Memorandum of Understanding between the FASB and IASB last decade. With country after country adopting IFRS as its accounting standards and the SEC allowing foreign companies to file financial statements under IFRS unreconciled to U.S. GAAP and poised to tell U.S. public companies they would have to file under IFRS as well, it seemed the path to a single set of international standards was set and inevitable.
Then something happened.
I don’t know if the SEC got cold feet, had legitimate concerns or simply got distracted by its many other duties, but for whatever reason, the SEC stopped the push toward requiring domestic U.S. companies to adopt IFRS. Then the camaraderie of the FASB and IASB working on standards together started to crumble; first with differences on financial instrument impairment, then deciding to go their own ways on insurance and finally taking completely different directions on the income statement presentation of leases. Even the crowning achievement of a single revenue standard is starting to show the cracks in the relationship with the Boards taking different positions on the need for additional guidance on revenue related to licenses and more guidance on how to determine performance obligations.
Through all of this, I still thought that global standards made sense, if only we could work together. Then an IASB Board member opened their mouth and changed my opinion, maybe forever. In discussing potential additional guidance on the revenue standard the IASB Board member said (I paraphrase) “I never thought you would actually have to do this revenue accounting on a contract by contract basis.” The worst part was no IASB Board member called him out for such a statement.
In the U.S. when a standard says “the objective of the guidance on this topic is to establish principles that an entity shall apply to report useful information to users of financial statements about the nature, amount, timing and uncertainty of revenue and cash flows from A CONTRACT WITH A CUSTOMER” as ASC 606-10-10-1 states, that means the standard is intended to be accounted for on a contract by contract basis. That fact is made even clearer by ASC 606-10-10-4 which states “this guidance specifies the accounting for an individual contract,” but says we can use a portfolio approach if the results “would not differ materially from applying this guidance to the individual contracts.” For those of you saying I am quoting the FASB codification and not IFRS 15 which the IASB member would be referencing, IFRS 15 says the exact same thing.
The rest of the world is clearly a very different place legally and regulatorily than the U.S. If members of the IASB can say the standard wasn’t meant to do what it says in plain English and not be called out, then my only conclusion is that the rest of the world views accounting standards very differently from the SEC and the U.S. Courts and we dare never subject ourselves to a standard setting body that doesn’t recognize and help preparers and auditors deal with such differences.
The FASB and IASB issued their converged revenue recognition standard on Wednesday, May 28. The 700 page document can be found here (ASC 606, Other ASC Conforming Changes, Basis for Conclusions and Implementation Guidance). While the standard is not effective until 2017, there is no time to wait to begin your implementation work on this one. If you are at a public company planning a retrospective approach you have just 7 months until you need to start computing those “prior year” amounts for your 2017 financials. You have an extra year if you are a private company and only have to report one year of comparative income statement amounts, but if you enter into long-term contracts you may already be past the time when you need to start gathering information for changes to your revenue recognition related to those contracts.
The new revenue recognition standard may be the most significant change to accounting standards in the 40 year history of the FASB. The exact impact depends on the type of business on which you report. Software, telecom and technology in general are likely to see the most significant impacts, but every type of business is likely to see some level of changes which will require new processes, new controls and possibly new accounting systems. You can see more about the changes in a Journal of Accountancy Article here. If you want to hear more about the telecom industry impact you can listen to a podcast interview of me by JOA editor Ken Tysac here.
The most significant changes in the revenue recognition standard are:
- Elimination of the contingent (cash) cap on recognizing revenue
- Deferral of all costs to obtain and fulfill a contract – this is no longer a policy election (where upfront recognition was considered “better” accounting – how ironic) and the deferral can no longer limited to the amount of revenue that you deferred
- Sales incentives that used to be considered an expense are now considered a (separate) performance obligation and must have revenue allocated to that obligation.
- Change in the hierarchy of support for “stand-alone selling price” (SSP) and the return, in some cases, of the residual method for computing SSP
I will cover each of these changes in more detail in future blogs, but in summary this standard will likely require earlier recognition of revenue and later recognition of expenses than currently allowed in GAAP. Whether that is good or bad is up to you.
Unless you’ve been under a rock for the last three years, you should know by now that the FASB (and IASB) are proposing significant changes to the accounting standards on leasing that will require virtually all leases to be included on the balance sheet. I have seen many discussions on whether leases actually belong on the balance sheet as well as discussions on the proper income statement presentation of leases. I’ve also seen several write-ups on how the standard would result in leasing cash payments being place all over the statement of cash flows rather than being neatly tucked away in operating cash flow as it is today. I do not intend to get into those topics here.
What I want to bring up is how the new leasing standard may impact the reporting of a significant non-GAAP disclosure for many companies – Capital Expenditures. Capital Expenditures (or Cap Ex) is a significant metric that many investors take a high interest in when companies report their quarterly and annual numbers. It’s an indicator of internal investment opportunities and management’s intent to grow the business organically rather than through acquisitions among many other things.
Today, most companies already include a significant intangible asset in their Cap Ex number – software acquisitions. But also today, most companies do not include another intangible asset – the right to use (RTU) of leased items – because that right to use is not recorded on the balance sheet (unlike software). I know capital leases are included on the balance sheet, buts let’s face it, a vast majority of leases are not capital leases and many companies work very hard to make their lease terms result in the lease being considered an operating lease to ensure they don’t have to recognize the lease on the balance sheet. As a result many companies report Cap Ex as the amount of cash paid for PP&E and software in the investing section of the statement of cash flows.
That brings us to the new leasing standard. The standard is very clear that the initial recording of the RTU asset is a non-cash transaction (debt RTU, credit lease liability). In fact the standard requires disclosure of the amount of RTU initially recognized during the reporting period as a supplemental non-cash item. So that brings me to my question – will companies redefine Cap Ex – remember this is a non-GAAP term so the FASB doesn’t really have any say over it – to include the noncash RTU asset or not? I don’t know the answer, but it will be interesting to watch because I see it as a referendum of sorts on the FASB position that all leases are really just a form of financing. If preparers and investors agree with the FASB, then the Cap Ex numbers will be adjusted to include the RTU amount acquired during the year. If preparers do not agree, and investors implicitly support the preparers by not adjusting the Cap Ex results for the clearly disclosed non-cash item, then maybe they are saying the FASB is wrong and leasing is something more or different from just another form of financing.
It seems the fissures in the IASB-FASB relationship have continued to grow and risk becoming so fractured that the U.S. movement to IFRS may be put off indefinitely.
The latest salvo game from IASB chairman Hans Hoogervorst. His statement that the IASB has “broken deadlines so often that nobody believes in them anymore” seems to be purely a self assessment at first blush, but in standard setting, like politics, nothing is ever that simple. The IASB Chairman also referred to “dysfunctional working processes and dysfunctional decision making” in his recent self assessment of the IASB. Considering the FASB is part of that decision making process and the only standards singled out as issues where joint projects, one has to believe at least some of the criticism was squarely aimed at the FASB.
Mr. Hoogervoorst also laid down the gauntlet that the IASB would finish its conceptual framework project by September 2015. Given that aggressive time frame, it is clear the IASB won’t have time to work with the FASB on any convergence projects once the big three – revenue recognition, leases and financial instruments are complete. In fact, one has to wonder if the IASB will continue to work closely with the FASB to work out a single solution on those projects – in particular the leasing project – or if they will simply go their own what and effectively tell the FASB you can come along or not; we don’t care which you do.
And the IASB also seems to be getting the backing of the EU with comments from officials referring to stakeholders impressions that “we are going backwards” on accounting standards. The EU has even raised the idea of kicking the SEC off of the monitoring board providing oversight to the IASB. While that has not happened, if it ever does, it will be very interesting to see the SEC response. Given the SEC’s mandate through law about accounting standards, would the SEC be willing to continuing accepting financial statements based on accounting standards they have no oversight on whatsoever?
So it increasing looks like we may have a world of two or three (never count out the Chinese) major sets of accounting standards. A friend on mine from Canada mentioned this is increasing starting to look like the adoption of the metric system. The U.S. initially puts out plans to adopt the metric system, but never really gets on board with the rest of the world. That leaves business stuck in the middle dealing with users of both systems and muddling through as best they can.
A few months ago the FASB and IASB made an announcement that didn’t make many headlines, but it now seems to be significant statement about the future of “a single set of global accounting standards.” The statement essentially said that the Boards were not seeing a lot of benefit, and were seeing increasing costs, in continuing to work jointly on new standards. It went on to state that when the current list of convergence projects was complete, no new projects would be undertaken by the Boards working as a single unit. On the one hand, if all of the convergence projects were completed, one could come to the conclusion that there really wouldn’t be many differences left to work on anyway. On the other hand, this might have been seen as a prophetic statement of the inability of the Boards to see eye-to-eye on what the appropriate accounting standards should be.
In isolation, this announcement might not seem like much, but since then two more events have occurred to put that announcement in new light. First, the SEC staff issued its final work plan with no recommendation of how or when to transition the U.S. (public company reporting) to IFRS. Second, the FASB made several tentative decisions on the accounting for impairments of financial instruments that will take the U.S. in a different direction than the current proposal from the IASB.
Looking at the work plan report, it seems clear there are several layers of concern with IFRS that the FASB seems to be latching onto in its renewed assertiveness. First, the notion that U.S. standards are somehow prescriptive and IFRS’s are principle based was somewhat debunked by the SEC. Sure the U.S. standards tend to come with a lot more guidance, but that has the benefit of reducing diversity in practice and isn’t that the point of a single set of standards. Second, the SEC hinted that IFRIC (the IASB equivalent of the EITF) isn’t doing a job good enough for the U.S. market and would need to be much more active if the U.S. were to ever adopt IFRS. In a document as politically sensitive as the work plan report, that hint was the same as you or me yelling something at the local town square.
The work plan report also pointed out that IFRS continues to be underdeveloped in several critical areas (e.g. regulated industry and investment company accounting) and effectively said going pure IFRS and eliminating standards in these areas would be a major step backwards for U.S. investors. The work plan seems to suggest a major role for the FASB if the U.S. were to ever adopt IFRS by apparently promoting an endorsement process as the best way to eventually incorporate IFRS into the U.S. market.
With this renewed support from the SEC, the FASB appears to have decided that they don’t have to get along with the IASB if they don’t want to. The first salvo is the aforementioned decisions on financial instrument impairments, but I am wondering what is next. We’ve already seen cracks in the unified solution to leasing. Will a single standard in that complicated area also disappear like a balloon in the wind? And what about revenue recognition? The re-deliberations on that standard have just begun. Is more contention on that final standard coming as well? I sure don’t know the answers to those questions, but like fans flocking to a NASCAR race, many of us will be looking on not to see the results of the race but to watch the wrecks happen along the way.
The FASB is at it again, issuing an Exposure Draft on potential new Liquidity Disclosures. Normally when I see such topics from the standard setters, my heart goes out to my colleagues in the banking and financial services sector, but this time the FASB is hitting up every business with new disclosure requirements. The requirements for all business include a new “available funds table” that shows all liquid funds available to the entity and an “expected cash flow obligations table” that shows cash flow payment obligations including recorded and off-balance sheet commitments.
I found the timing of this ED interesting for two reasons. First, this ED is really part of the overall Financial Instruments project, but for some reason the Boards (the IASB is also working on the Financial Instruments project) decided to go ahead and release an exposure draft covering only these disclosure requirements and not wait to issue a more comprehensive document on the entire Financial Instruments project. Second, the FASB had just initiated work on a Financial Statement Disclosure project which, if complete, would provide valuable insight into the benefit and cost of yet more disclosures.
In fact, looking at these disclosures, one has to wonder what is being gained. Public companies are already required to give similar information as part of the SEC contractual obligations table and MD&A discussions on liquidity. Most companies, public or private already disclose information on the timing of recorded long-term debt payments in their footnotes, and the most significant off-balance sheet obligation – leases – already has requirements about disclosing future minimum lease payment obligations by year. The FASB even appears to acknowledge these potential overlaps by specifically asking about it in the questions they ask respondents to address in their comment letters.
On first blush, the difference may be that the FASB wants management to base the disclosures on “expected maturities” rather than “contractual maturities.” To put that in simple terms think of debt with a December, 2015 contractual payoff date. Currently any reporting would be based on this hard and fast contractual date. Under the proposed approach, management needs to take into account any potential plans to refinance the debt and possible defer the payment period. It is also possible management will redeem the debt early and that would need to be reflected as well. Can you imagine the fun we preparers will have debating the expected maturity timing with our auditors?
Whether the FASB should have waited until it completed its Disclosure project before issuing a proposal for yet more disclosures is a mute point now that the document has been issued. You have until September 25 to let the FASB know your feelings on this one. I doubt it will get the number of letters that Revenue Recognition and Leases generated, but maybe that is the problem. Everyone complains about disclosure overload, but when it comes time to make a point to the very institution causing the overload, no one seems to want to take the time to let them know enough is enough.
The FASB and IASB are taking time to look at their future agendas once the convergence efforts around revenue recognition, leasing and financial instruments are complete. I cringe at the thought of the Boards once again taking up the subject of financial statement presentation, but I am pleased to see the FASB dusting off their long dormant disclosure framework project. Although, I do have to wonder if it’s just one more attempt to put on the show that they now “get” private company issues while in the end not really doing anything for private company reporting.
Cynicism aside, there is one project I wish the Boards would add to their agenda – accounting for intangible assets. Some want to expand it even more and go after intellectual property, but I disagree. intellectual property would seem to include things like the value of a company’s workforce which I do not believe are accounting assets of a company. One of the most important qualities of an asset is the ability of the company to control it. Control includes the concept of selling it to someone else. That idea simply doesn’t apply to employees, at least not in this or any other country that bans slavery.
But even when you limit the discussion to intangible assets, it is clear our current accounting model is woefully underdeveloped. The Boards are making a big point in their leasing discussions that they believe it is important for economically similar transactions – lease versus a financed purchased – should be reflected in a similar manner in the financial statements. It would seem to me that current standards for Intangible Assets are at least as egregious as the leasing standards.
Take the case of two companies. Both make $1 million investments in a patent. The first company spends the money on an internally developed patent. What do they have to show for this investment? $1 million in expense. The second buys a patent from another company. What do they have to show for their deal making prowess? A $1 million asset. Assuming the patents have equal value, economically, both companies are in the same position. The same cannot be said on for current or future year financial results. The current year expense and asset differences are only the start. In future years, the companies will show different return on asset ratios, different net income margins and so forth.
Obviously there are a number of potential issues with taking on the accounting for intangible assets, the most important of which is valuing all of the intangible assets created and maintained each year. The continued evolution of fair value accounting is forcing all CPAs to become at least proficient if not highly skilled in valuation techniques. If you don’t believe me, just check out the SEC’s recent discussion on the use of pricing services – if you don’t understand the assumptions and models used by the pricing services than you have a control deficiency as a preparer and an audit deficiency as an auditor. I guess if they are going to force us to become experts in valuation of assets, we might as well use those talents for something that truly improves financial reporting like finally addressing the inconsistency in accounting for intangible assets.