The new revenue recognition standard - FAQs about SEC reporting and transition

In transition Aug 09, 2017

As the effective date approaches, questions have arisen about how the new revenue standard impacts SEC reporting and disclosure.

Overview

The new revenue recognition standard (ASC 606) will have a significant financial reporting impact for many companies. As the effective dates approaches, questions have arisen as companies navigate through implementation. This publication provides our views on frequently asked questions, with a focus on SEC reporting matters, disclosure, and transition implications under US GAAP. It also addresses the implications of the new standard for equity method investees and business acquistions.

 

Impact on equity method investees

Question 1:

An equity method investee of an SEC registrant is considered significant under Rule 3-09 of Regulation S-X and therefore, its financial statements are included in the investor’s SEC filings. The investee is a private company that otherwise does not meet the definition of a public business entity. What is the required adoption date of the new revenue standard for the investee?

Answer:

The investee can elect to adopt the new revenue standard according the timeline of a public business entity (annual reporting periods beginning after December 15, 2017, including interim periods therein) or a private company (annual reporting periods beginning after December 15, 2018). The investee meets the FASB’s definition of a “public business entity” because that definition includes entities whose financial statements or financial information are included in an SEC filing (such as when a registrant’s equity method investee is considered significant under Rule 3-09 or Rule 4-08(g) of Regulation S-X). However, at the July 20, 2017 EITF meeting, the SEC Observer stated that the SEC would not object if entities adopt the new revenue standard according to the timeline otherwise afforded private companies if they meet the definitionof a public business entity solely due to the inclusion of their financial statements or financia information in another entity’s SEC filing.

If an investee elects to adopt the new revenue standard according to the private company timeline, the investor’s associated income or loss pickup under the equity method of accounting does not need to be adjusted to reflect adoption according to the public business entity timeline.

For additional information, refer to In brief US 2017-22, SEC extends revenue and leases effective dates for certain PBEs.


Question 2:

Must an equity method investee apply the same transition method as its investor to adopt the new revenue standard?

Answer:

No. Upon adoption of the new standard, the equity method investee can elect either method of transition (i.e., full retrospective as described in ASC 606-10-65 1(d)(1) or modified retrospective as described in ASC 606-10-65-1(d)(2)). The method of transition does not need to be the same as the investor’s. The investor will need to consider the impact of the equity method investee’s election on its financial statements. For example, if the equity method investee adopts the new revenue standard using the full retrospective method, the registrant will need to recast the associated income or loss pickup for the prior periods presented, including all related metrics (e.g., earnings per share), even if the registrant elected the modified retrospective transition method.


Question 3:

A registrant adopts the new revenue standard as of a different date and/or under a different transition method than its equity method investee. Should the registrant conform the equity method investee’s transition dates and methods to its own for purposes of performing the significance tests under Rules 3-09 and 4-08(g) of Regulation S-X?

Answer:

No. The SEC staff clarified in Financial Reporting Manual (FRM) 11120.2 that the registrant is not required to conform the transition dates and/or methods for purposes of performing significance testing of equity method investees. For example, if the registrant adopts the new revenue standard on January 1, 2018, but the equity method investee will not adopt until January 1, 2019, the registrant is not required to adjust the investee’s financial information to reflect adoption as of January 1, 2018 for the purpose of significance testing.


Question 4:

Should a registrant that adopts the new revenue standard using the full retrospective transition method recompute the significance of its equity method investees in prior periods under Rules 3-09 and 4-08(g) of Regulation S-X?

Answer:

No. The SEC staff clarified in FRM 11120.1 that a registrant does not need to recompute the significance of equity method investees in prior periods using financial information revised to reflect adoption of the new revenue standard. For example, if a registrant adopted the new revenue standard on January 1, 2018 using the full retrospective method, the registrant would not need to recompute the significance of an equity method investee in 2016 and 2017.

 

Impact on business acquisitions and dispositions

Question 5:

A registrant acquires a private company in 2018 that is considered significant and as such, financial statements are required to be filed under Rule 3-05 of Regulation S-X. The private company otherwise does not meet the definition of a public business entity. Are the financial statements of the acquiree included in the Form 8-K required to reflect adoption of the revenue standard according to the timeline of a public business entity since the entity’s financial statements are included in an SEC filing?

Answer:

No. As discussed in Question 1, the SEC would not object if entities adopt the new revenue standard according to the timeline otherwise afforded private companies (annual reporting periods beginning after December 15, 2018) if they meet the definition of a public business entity solely due to the inclusion of their financial statements or financial information in another entity’s SEC filing.


Question 6:

A registrant makes an acquisition subsequent to adopting the new revenue standard. The registrant adopted the new revenue standard as of a different date and/or under a different transition method than its acquiree. Should the registrant conform the acquiree’s transition dates and methods to its own for purposes of performing the significance tests under Regulation S-X?

Answer:

No. The SEC staff clarified in FRM 11120.2 that the registrant is not required to conform the transition dates and/or methods for purposes of performing significance testing under Regulation S-X. The FRM provides an example of significance testing for an equity method investee; however, this guidance would also apply to significance testing for acquirees.


Question 7:

A registrant makes a significant acquisition subsequent to adopting the new revenue standard. The registrant adopted the new revenue standard as of a different date and/or under a different transition method than its acquiree. Should the registrant conform the acquiree’s transition date and method of adoption to its own in the Regulation S-X Article 11 pro forma financial information?

Answer:

Yes. The SEC staff clarified in FRM 11120.3 that the registrant should conform the acquired business’s transition date and method to its own in the Article 11 pro forma financial information. For example, assume a calendar year-end registrant adopts ASC 606 using the full retrospective transition method as of January 1, 2018. In September 2018, the registrant acquires a company that adopted the new revenue standard using the modified retrospective transition method. The acquisition was determined to be significant under Regulation S-X. The Article 11 pro forma financial information for the acquisition should reflect the impact of the acquiree’s adoption of ASC 606 using the full retrospective transition method.


Question 8:

A registrant adopts the new revenue standard on January 1, 2018 using the full retrospective transition method. In September 2018, the registrant makes a significant acquisition and will file a Form 8-K that includes pro forma financial information for the year ended December 31, 2017 and the six months ended June 30, 2018. Is the registrant required to reflect retrospective adoption of the new revenue standard in the 2017 Article 11 pro forma information included in the Form 8-K even though the historical financial statements of the registrant do not reflect the adoption of the new revenue standard?

Answer:

No. The SEC staff clarified in FRM 11120.4 that the registrant does not need to apply the new revenue standard to Article 11 pro forma financial information for the year ended December 31, 2017 (i.e., the period prior to adoption) in this fact pattern. This is because at the time of the Form 8-K filing, the 2018 Form 10-K had not been filed. Therefore, the registrant’s financial statements for the year ended 2017 have not been updated to reflect the new revenue standard. If the registrant has not reflected the adoption of the new revenue standard in its 2017 financial statements and believes the effect of the new standard on 2017’s historical financial information will be material, it should consider making appropriate disclosures in the notes to the pro forma financial information in the Form 8-K.

We believe that if the registrant had filed 2017 financial statements that reflected the adoption of the new revenue standard, the registrant would need to reflect the adoption in the 2017 Article 11 pro forma financial information in the Form 8-K. For example, if as a result of a new registration statement the registrant updated the previously issued 2017 financial statements to reflect adoption of ASC 606, the Article 11 pro formas would also need to reflect the adoption of ASC 606.


Question 9:

On January 1, 2018, a registrant adopts the new revenue standard using the full retrospective transition method. In July 2018, the registrant acquires a company that has not yet adopted the new revenue standard. Should the 2018 and 2017 pro forma revenue and earnings disclosures required by ASC 805 reflect the effects of adopting the revenue standard?

Answer:

Yes. Absent justification for different accounting policies, the acquiree’s policies should be conformed to those of the acquirer. In addition, pro forma revenue and earnings of the combined entity should be presented on the same accounting basis as the accompanying financial statements. ASC 805 allows for an impracticability exception for including the disclosures; however, we believe meeting this exception is a high hurdle not generally observed in practice.


Question 10:

In July 2017, a registrant acquires a business and discloses 2017 and 2016 pro forma revenue and earnings of the combined entity under ASC 805 in its 2017 Form 10-K. On January 1, 2018, the registrant adopts the new revenue standard using the full retrospective transition method. Should the registrant update its 2017 and 2016 ASC 805 pro forma disclosures to reflect the effects of adopting the new standard in its 2018 Form 10-K?

Answer:

Yes. ASC 805 pro forma revenue and earnings of the combined entity should be presented on the same accounting basis as the accompanying financial statements. ASC 805 allows for an impracticability exception for including the disclosures; however, we believe meeting this exception is a high hurdle not generally observed in practice.


Question 11:

A registrant adopts the new revenue standard on January 1, 2018 using the modified retrospective transition method. In July 2018, the registrant acquires a business. How should the 2018 and 2017 pro forma revenue and earnings of the combined entity be disclosed under the provisions of ASC 805?

Answer:

As noted in Questions 9 and 10, the pro forma revenue and earnings of the combined entity should be presented on the same accounting basis as the acquirer’s accompanying financial statements. In this example, the 2018 pro forma revenue and earnings of the combined entity should reflect the effects of adopting the new revenue standard. However, the 2017 pro forma revenue and earnings of the combined entity would reflect the accounting principles presented in that period, which is prior to the adoption of the new revenue standard.


Question 12:

On January 1, 2018, an entity adopts the new revenue standard using the full retrospective transition method. The entity’s comparative income statement for 2017 and 2016 reflect discontinued operations. Should the entity reflect the adoption of the new revenue standard on the discontinued operations presented in prior periods?

Answer:

Yes. If material, the entity should reflect the effects of adopting the new revenue standard on the discontinued operations presented in prior periods.

 

Registration statements filed after the effective date of the new revenue standard

Question 13:

If an entity files a Form S-1 in preparation for an initial public offering (IPO) in 2018, is the entity required to adopt the new revenue standard?

Answer:

It depends on whether the entity qualifies as an emerging growth company (EGC) under the JOBS Act. Ordinarily, an entity preparing an SEC filing (including a private company filing a Form S-1) must apply all accounting standards as if it had always been a public entity. As part of the IPO relief provided to EGCs, an EGC may elect to adopt new standards on the timeline afforded a private company. This election must be applied to all new accounting standards. An entity that does not qualify as an EGC is required to adopt the new revenue standard on a public business entity timeline.


Question 14:

A registrant adopts the new revenue standard effective January 1, 2018 using the full retrospective transition method and files its first quarter 2018 Form 10-Q on that basis. The registrant decides to file a Form S-3 to register the future sale of securities in July 2018. Does the adoption of the new revenue standard impact the registrant’s Form S-3 reporting requirements?

Answer:

Yes. Item 11(b) of Form S-3 requires the registrant to update its previously issued audited annual financial statements included in its most recent Form 10-K to give retrospective treatment to the adoption of a new accounting standard, if material. In this example, this would require recasting an additional year (2015) under the new revenue standard because it is reflected in the 2017 Form 10-K, even though only 2016 to 2018 will be reflected in the 2018 Form 10-K. However, the registrant could consider the guidance in ASC 250, Accounting Changes and Error Corrections, which provides an ability to assert that it is impracticable to recast historical financial information.

For additional information, refer to In depth US 2016-11, 2016 AICPA Conference: Highlights of the 2016 AICPA Conference on Current SEC and PCAOB Developments.


Question 15:

Assume the same facts as Question 14 except that the registrant conducts a registered direct offering of its securities as a takedown off of an existing shelf registration statement. Does the adoption of the new revenue standard impact the registrant’s reporting requirements in connection with this offering?

Answer:

Probably not. The registrant would not need to recast prior year information unless it concludes the adoption of the new revenue standard represents a “fundamental change,” which is a legal determination.

For additional information, refer to In depth US 2016-11, 2016 AICPA Conference: Highlights of the 2016 AICPA Conference on Current SEC and PCAOB Developments.


 

New revenue standard disclosure requirements

Question 16:

What information should registrants disclose about the expected impact of the new revenue standard prior to adoption (SAB 74 disclosures)?

Answer:

Registrants are required to disclose both quantitative and qualitative information regarding the expected impact of adopting new accounting standards. These disclosures should evolve and become more detailed as registrants progress in their implementation and should be aligned with information communicated to audit committees and investors.

Registrants should disclose known or reasonably estimable quantitative information about the expected impact of the new revenue standard, even if such information is only available for a particular subset of the registrant’s arrangements (e.g., a product category or type of revenue). When assessing whether the impact of the new standard on a registrant’s financial statements is material, registrants should consider the new disclosures required by the standard in addition to the impact on the recognition, measurement, and presentation of revenue transactions.

If a registrant does not know or cannot reasonably estimate the expected financial statement impact, then in addition to making a statement to that effect, the registrant should consider additional qualitative disclosures to assist the reader in assessing the impact of the standard. Additional qualitative disclosures should include a description of the effects of the accounting policies that the registrant anticipates applying, if determined, and a comparison to the registrant’s current accounting policies. For example, if a registrant has not yet completed its analysis of the impact of the new revenue standard on its licensing arrangements, it should consider disclosing, at a minimum, the expectation the timing of revenue recognition for licensing arrangements may be accelerated to “point-in-time” recognition under the new standard from “over time” recognition under current policies. A registrant should also describe the status of its process to implement new standards and the significant implementation matters yet to be addressed.

For additional information, refer to EITF Observer from September 2016 and In depth US 2016-11, 2016 AICPA Conference: Highlights of the 2016 AICPA Conference on Current SEC and PCAOB Developments.


Question 17:

Are registrants required to provide all annual disclosure requirements of the new revenue standard for each interim period in the initial year of adoption?

Answer:

Yes. Article 10 of Regulation S-X requires registrants to disclose material matters that were not disclosed in the most recent annual financial statements. Accordingly, when a registrant adopts the new revenue standard in the first quarter, the registrant is expected to provide both the annual and the interim period disclosures prescribed by the standard, to the extent not duplicative. These disclosures should be included in each quarterly report in the year of adoption (that is, in the registrant’s first, second and third quarter Form 10-Q filings).


Question 18:

Are registrants that adopt the new revenue standard using the full retrospective transition method required to apply the new guidance to each of the five years included in the selected financial data table in their Form 10-K filing?

Answer:

No. The SEC staff clarified in FRM 11110.1 that registrants are not required to apply the new revenue standard to periods prior to those presented in its retroactively-adjusted financial statements. Therefore, registrants are not required to adjust years four and five of the selected financial data table as long as the registrant clearly discloses the different accounting basis applied to those years.


Question 19:

For reporting periods in the year of adoption, the new revenue standard requires entities who select the modified retrospective transition method to provide disclosures about the impact of applying the new standard, including the amount by which each financial statement line item is affected as a result of applying the new guidance as compared to previous guidance. Do these disclosure requirements also apply to periods following the year of initial application?

Answer:

No. The disclosures outlined in ASC 606-10-65-1(i) are only required for periods (interim and annual) that include the date of initial application. An entity that adopts the standard on January 1, 2018 is only required to provide the disclosures for the 2018 annual period (and interim periods therein).


Question 20:

The new revenue standard requires various quantitative disclosures. For which periods should these disclosures be provided?

Answer:

If a disclosure relates to a balance sheet account (e.g., the opening and closing balances of contract assets and liabilities), the information should be provided for each period a balance sheet is presented that reflects adoption of the new revenue standard. If a disclosure relates to an income statement account (e.g., revenue recognized during the period), the information should be provided for each period an income statement is presented that reflects adoption of the new revenue standard.


Question 21:

Are entities that adopt the new revenue standard using the modified retrospective transition method required to provide the new required disclosures for the comparative periods prior to the adoption date?

Answer:

No. An entity that adopts using the modified retrospective transition method will not need to restate prior periods to reflect adoption of the new revenue standard; therefore, the new disclosures for those prior periods are not required.

 

Other adoption date and transition matters

Question 22:

Public business entities reporting under US GAAP are permitted to adopt the new revenue standard early, but only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods therein. Can an entity adopt the new revenue standard in a period other than the first quarter (e.g., in the second, third or fourth quarters)?

Answer:

No. A public business entity that is adopting the new revenue standard early must adopt the standard in the first quarter.


Question 23:

An entity concludes that a collaboration arrangement is not in the scope of the current revenue standard (ASC 605); however, the entity applies the revenue guidance by analogy to account for the arrangement. Is the entity required to apply the new revenue standard to this arrangement once it is effective and if so, which transition guidance would apply?

Answer:

The entity should first assess whether the arrangement is in the scope of the new revenue standard. If not, an entity could apply the new revenue standard by analogy once the new guidance is effective, utilizing the new standard’s transition guidance (e.g., the entity could elect either transition method and could apply the related practical expedients). We believe that an entity is not required to apply the new revenue standard by analogy in this scenario; however, the entity would need to be able to support its basis for its accounting conclusions, which should not be based on superseded guidance (e.g., ASC 605). An entity that does not transition to applying the new revenue standard by analogy should also consider whether it is making a change to its accounting policy that should be assessed under ASC 250 (including a preferability analysis).


Question 24:

An entity historically concluded that its pre-production activities (e.g., the design and development of products based on the needs of a customer) meet the definition of a deliverable under current revenue guidance (ASC 605). Should these activities be accounted for as performance obligations under the new revenue standard?

Answer:

It depends. The entity should evaluate whether its pre-production activities are a promise to transfer a good or service based on the guidance in the new revenue standard, including consideration of the TRG’s discussion of pre-production activities (TRG Memo No. 46). We expect that the conclusions under the new revenue standard will often be consistent with those under the previous revenue guidance. However, there could be some instances when an entity historically concluded pre-production activities met the definition of a deliverable, but concludes that the activities do not transfer a good or service under the new revenue standard.


Question 25:

An entity historically concluded that its pre-production activities are not a revenue-generating activity because the activities are not part of its “ongoing major or central operations” under the FASB Concepts Statement No. 6 definition of revenue or because the activities were considered fulfillment or development activities. Should these activities be accounted for as performance obligations under the new revenue standard?

Answer:

If an entity previously concluded that pre-production activities were not a revenue-generating activity, we would expect the entity to reach a similar conclusion upon adoption of the new revenue standard. Therefore, assuming no other change in facts and circumstances, the entity would not account for these activities as performance obligations. It is unclear whether accounting for these activities as performance obligations would be acceptable, and whether such a change would be a change to the entity’s accounting policy that should be assessed under ASC 250 (including a preferability analysis).


Question 26:

An entity incurs costs that it historically concluded are in the scope of existing guidance on pre-production costs related to long-term supply arrangements (ASC 340-10), which has not been superseded by the new revenue standard. Can the entity elect to apply the new cost guidance in ASC 340-40 to these costs as part of its adoption of the new revenue standard?

Answer:

No. If an entity chooses to change the accounting for costs that it historically concluded are in the scope of existing cost guidance (that will not be superseded), the entity should apply the guidance on accounting changes in ASC 250. That guidance requires an entity to conclude that an alternative accounting principle is preferable and requires retrospective application of the new accounting principle to all prior periods. Conversely, if the costs are not in the scope of existing cost guidance (such as ASC 340-10), but the entity historically applied the guidance by analogy (due to the absence of other applicable guidance), it should assess whether the costs are in the scope of the new cost guidance in ASC 340-40 in connection with its adoption of the new revenue standard. Application of ASC 340-40 in this scenario should follow the transition guidance in the new revenue standard.


Question 27:

In January 2017, prior to adopting the new revenue standard, an entity enters into a contract with Customer A to lease equipment and provide professional services. The entity allocates consideration between the lease and revenue components in accordance with current accounting guidance (i.e., ASC 840 and ASC 605). The entity adopts the new revenue standard as of January 1, 2018 and will apply the new guidance to the contract with Customer A in connection with its adoption. Assume the entity has not yet adopted the new leasing standard (ASC 842). Is the entity required to reassess the allocation of consideration to the components in the contract with Customer A?

Answer:

No. The FASB clarified at its June 21, 2017 meeting that it did not intend for an entity to revisit the allocation of consideration to lease components in connection with the adoption of the new revenue standard. We believe an entity could choose to reassess the allocation between the revenue and lease components of the contract, but is not required to do so. We expect that, in many cases, the allocation between a revenue and lease component in a contract would not change significantly as a result of applying the guidance in the new revenue standard; however, the allocation could change due to certain differences in the allocation guidance (e.g., specific guidance on the allocation of discounts and variable consideration in the new standard).

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