The January 2018 effective date of the new revenue standard for most public business entities (PBEs) is quickly approaching. To help you prepare, we hosted a webcast with executives from companies that already adopted the standard. The webcast panelists shared their experiences, lessons learned, and advice for those working through the transition, including the following best practices.
One common observation related to the level of effort needed to address the disclosure requirements. Many disclosures require judgment. For example, companies must disclose information about the methods, inputs and assumptions used to determine and allocate transaction price among performance obligations. Companies may need to collect additional information that may necessitate changes to information systems, or require coordination across business functions.
Adoption of any new standard can bring logistical challenges. As a result, companies should consider running a parallel financial statement close process at an interim date. This may help address the following questions:
For more information, listen to the archived webcast Revenue recognition change: Lessons learned from Alphabet, Ford, & Lockheed Martin.
As we approach the fourth quarter, many companies are preparing for their annual goodwill impairment testing. If that's you, here are some helpful reminders.
Under the new goodwill impairment guidance, an impairment loss will be recognized to the extent the carrying value of a reporting unit exceeds its fair value (not to exceed the carrying value of the goodwill). To determine fair value, companies must determine whether a hypothetical sale would be taxable or nontaxable. This determination could impact whether a company has a goodwill impairment and the amount of any impairment. Goodwill impairment guidance requires companies to use a market participant perspective in making this determination. Therefore, any change in the taxable or nontaxable determination from the prior year should be supported by a change in market participant circumstances.
If goodwill and long-lived assets (held and used) are being tested at the same time because of a triggering event, it is important to remember the order of impairment testing. Prior to testing goodwill for impairment, companies should first test other assets (e.g., accounts receivable, inventory) and indefinite-lived intangible assets. Then long-lived assets, including definite-lived intangible assets, are tested and finally, goodwill. Any impairments from each test should be recorded before performing the next test.
The new goodwill impairment testing guidance may result in goodwill impairment charges that would not have been recorded under the previous method. When a goodwill impairment charge is recognized, it may indicate the need to assess impairment for other assets subject to trigger-based impairment tests.
See Goodwill impairment testing - tax considerations for more information on goodwill impairment income tax considerations. See our Business combinations and noncontrolling interests guide, Section 10.4.1.4 - Order of impairment testing for long-lived assets held-and-used for more information on the order of impairment testing.
A company may buy the stock of another entity whose only substantive asset is in-process research & development (IPR&D). In this scenario, the acquired entity would likely not meet the FASB's new definition of a business. This makes a difference because acquired IPR&D in an asset acquisition is immediately expensed whereas it is capitalized in a business acquisition.
The determination of whether the acquired entity is a business could also result in differences in the tax accounting for IPR&D. In a business combination, deferred taxes are recorded related to the acquired IPR&D asset. However, in an asset acquisition including IPR&D, since the IPR&D is expensed, a question arises as to whether deferred taxes should be recorded. We believe historical guidance1, applied by analogy, may support not recording deferred taxes on the acquired IPR&D in an asset acquisition.
The timing of tax reform is anyone's guess. In the event it happens in 2017, it's important to remember that changes in tax law are recorded when the law is enacted, not when they're effective. So if tax reform is passed in 2017 but is not effective until 2018, the impact on deferred taxes must be recorded in 2017. In addition, companies contemplating repatriation of foreign earnings in anticipation of tax reform should assess whether this changes their existing indefinite reinvestment assertions.
1EITF 96-7, Accounting for deferred taxes on in-process research and development activities acquired in a purchase business combination
The FASB's new hedging standard, issued in August, is a welcome change for preparers and users of financial statements. The new standard more closely aligns hedge accounting with companies' existing risk management strategies, simplifies the application of hedge accounting and increases transparency regarding the scope and results of hedging programs.
The FASB's new guidance:
While the new guidance is not effective until 2019 for calendar year-end public companies, early adoption is permitted in any interim or annual period. Thus, companies can adopt the new standard as early as the third quarter of 2017. Companies that early adopt in 2017 or 2018 will have to apply the new guidance as of the beginning of the year. The standard includes detailed transition provisions, including some that provide relief, but only if elected at the date of adoption.
Companies should perform an impact assessment of the standard, including the new presentation and disclosure requirements, when deciding whether to early adopt.
For more information, refer to In brief 2017-26, FASB issues final hedging guidance, can be adopted immediately, and watch our video on hedge accounting below.
In Q1 2018, calendar-year PBEs will have to adopt guidance that changes the accounting for equity investments and financial liabilities under the fair value option. The guidance also impacts the presentation and disclosure requirements for financial instruments.
The guidance changes the accounting for all types of equity investments, including those that are not securities (e.g., investments in partnerships), as well as certain forwards and options on equity investments that are not accounted for as derivatives. This also includes investments in the equity of investment companies that only hold debt securities. This is because the guidance does not permit an investor to “look through” the investment to determine recognition and measurement.
The most significant change to the accounting for equity investments is the elimination of the available-for-sale and cost methods of accounting. Equity investments in unconsolidated entities with a readily determinable fair value (other than those accounted for under the equity method) will be carried at fair value. Changes in fair value will be recorded in earnings.
The guidance provides a measurement alternative for certain equity investments without a readily determinable fair value (and those not eligible for the practical expedient to be measured at net asset value). If elected, the investment would be carried at cost plus or minus changes resulting from observable price changes in transactions of the same or similar securities of the same issuer. Companies will be required to assess the investment for impairment each reporting period under a new one-step approach.
The accounting for financial liabilities for which the fair value option has been elected will also change. For these liabilities, changes in fair value due to instrument-specific credit risk will be reported in other comprehensive income. This guidance does not apply to instruments required to be measured at fair value (e.g., derivatives) and does not change the measurement alternative available to collateralized financing entities.
For more information, see In depth 2016-01, New guidance on recognition and measurement to impact financial instruments, and Chapters 2 and 3 of our Loans and investments guide.
As the adoption date of the new leases standard draws closer, several implementation issues have been raised.
The accounting for embedded leases will change. Given this, questions have arisen about whether common arrangements, such as land easements, contain leases. The FASB decided that land easements entered into on or after the effective date of the new leases standard would have to be analyzed to determine whether they are leases. Pre-existing land easements would be subject to the entity's existing accounting policy for such transactions (i.e., as intangible assets or leases). The FASB also decided that any changes in the historical accounting policy for land easements existing before the effective date of the new leases standard would be considered a change in accounting policy. Changes in accounting policy require companies to demonstrate preferability.
Because certain variable payments are not included in the calculation of contract consideration, lessors may need to record a “day 1” loss for sales-type lease transactions that are profitable overall but have significant variable payments. Under current leasing guidance, leases with significant variable payments may have qualified as operating leases under certain additional criteria that were not carried forward to the new leases standard.
If an entity adopts the new revenue standard before the new leases standard, questions arose about whether the entity would be required to reallocate contract consideration between revenue and lease components upon adoption. While there is transition relief under the new leases standard that does not require reallocation, there is no explicit relief in the new revenue standard.
The FASB clarified that an entity should not reallocate contract consideration to lease components within the scope of the existing leases guidance when the entity adopts the new revenue standard.
For more information on these issues and other issues and technical corrections proposed by the FASB, refer to our latest In transition, Lease accounting implementation issues.
The AICPA proposed a draft framework for the valuation of financial instruments. The AICPA describes the primary goal of the framework as providing “valuation professionals with parameters of how much work should be performed and how to effectively and efficiently identify valuation documentation requirements.” In other words, the framework includes guidance on the performance of valuations and the extent of related documentation of key assumptions and judgments.
While voluntary, the scope of the AICPA's framework could have far-reaching impact. As drafted, it applies to all uses of financial instrument valuations, for example, for financial, regulatory, tax and management reporting. The AICPA believes it is relevant guidance for all individuals responsible for financial instrument valuations or for auditing them, including:
Certain portions of the framework may interact or overlap with other valuation and auditing guidance issued by other standard setters (e.g., FASB, IASB, PCAOB, IAASB), professional organizations and regulators.
As a result of its broad implications, we encourage those impacted, including companies with portfolios of financial instruments, whether valued internally or externally, to provide feedback. Comments are due to the AICPA by September 27, 2017.
In a related effort, the AICPA is developing a credential for qualified financial instruments valuation specialists. Credential holders will be required to follow the framework, and the AICPA will encourage others to do so as a best practice. Earlier this year, the AICPA finalized a credential for professionals performing valuations of business entities and intangible assets.
For more information, refer to AICPA Seeking Comment on Framework for Valuation of Financial Instruments.
In August, the FASB proposed rules to clarify how all entities should account for making and receiving grants. The proposed rules do not address the accounting for government grants received by business entities.
Under the proposed rules, companies would account for grants received as exchange transactions under the new revenue standard if the benefits of the grant flow directly back to the donor. However, if the grant's purpose is to benefit the public, the entity receiving the grant would account for the transaction as a contribution. For example, if a private foundation offers a pharmaceutical company a grant to conduct cancer research for the public good (rather than to provide the private foundation with proprietary rights to the research results), the transaction would be treated as a contribution. Certain contributions are recognized in the period made or received. This could be a change for business entities, as today, classification as an exchange transaction or contribution depends on the interpretation of existing guidance which has led to diversity.
New criteria in the proposal would also change the timing of revenue and expense recognition for certain transactions addressed by contribution accounting guidance. This could impact entities that make or receive grants, including business entities that make charitable grants through a corporate foundation.
The proposed amendments would have the same effective date as the new revenue standard, which is January 1, 2018 for PBEs with a calendar year end. Given the potential for changes to the timing of revenue and expense recognition so close to the effective date, entities that make or receive grants are encouraged to provide feedback. Comments are due November 1.
For more information, refer to FASB proposes improvements to not-for-profit grant and contribution accounting.
At the July EITF meeting, the SEC staff announced that certain PBEs can defer the new revenue and leases standards for one year using the effective dates applicable to private companies. This applies to those PBEs that are PBEs only because of the inclusion of their financial statements or financial information in another company's SEC filing. This announcement does not change the effective dates for other guidance for PBEs or change the definition of a PBE. For example, these PBEs will still have to adopt the standards for recognition and measurement of financial instruments, new cash flow presentation classification, presentation of net periodic pension cost, and the new definition of a business on January 1, 2018.
For more information, refer to In brief 2017-22, SEC extends revenue and leases effective dates for certain PBEs, and the Appendix.
The SEC's Division of Corporation Finance recently announced a policy change that expands the number of issuers that may apply certain registration accommodations originally only available to Emerging Growth Companies.
In nonpublic submissions, companies may exclude annual and interim period financial information not expected to be required at the time the registration statement is publicly filed.
The new rules were applicable beginning July 10.
For more information, refer to In brief 2017-20, SEC announces policy changes designed to facilitate capital formation, and In brief 2017-24, SEC provides additional relief to facilitate capital formation. Additionally, refer to the SEC's FAQs.
The SEC staff continues to review company disclosures under SAB 74 regarding the impact of adopting new accounting standards.
The importance of SAB 74 disclosures has been emphasized at various SEC speeches, including the need to provide information on (1) the status of a company's analysis, (2) the impact on disclosures, and (3) the qualitative impact of the standard.
Below is a summary of the potential impact of adopting the revenue, leases, and credit losses standards as disclosed in annual and quarterly filings by the Fortune 500 between July 1, 2017 to August 18, 2017.
Below is a summary of the expected method of adoption of the revenue standard as disclosed by the same companies.
Have you ever considered disclosures of new accounting standards (SAB 74) from the user’s point of view? Watch Gregory Johnson, a Director in our National Office with responsibility for many of our investor outreach activities discuss his thoughts on the user perspective.
Disclosures about recently issued accounting standards - the user’s view
On June 1, 2017, the PCAOB adopted a new standard intended to enhance auditor reporting, which is subject to SEC approval. The SEC is expected to take action on the proposed rule in October.
If approved, the most notable feature of the standard will be the requirement for auditors to communicate critical audit matters (CAMs) starting with reports issued for large accelerated filers for fiscal years ending on or after June 30, 2019. Reporting of CAMs is in response to stakeholders' desires to understand more about significant judgmental aspects of the audit. CAMs are defined as any matters arising from the audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) related to accounts or disclosures that are material to the financial statements and (2) involved especially challenging, subjective or complex auditor judgment. In identifying CAMs, the auditor will be required to take into account specific factors such as the auditor's risk assessment, areas in the financial statements that involved the application of significant judgment or estimation by management, significant unusual transactions, and the nature and extent of audit effort and evidence necessary to address the matter.
Other provisions of the standard, including the disclosure of auditor tenure and certain other changes to the form and content of audit reports, will be effective for calendar-year 2017 audits.
For more information, please see In brief 2017-15 PCAOB adopts new standard enhancing auditor reporting, and our response letter to the SEC consultation. And watch our video.
Watch PwC US Chief Auditor Len Combs' video update.
Companies are increasingly focused on income tax financial reporting due to political uncertainty, aggressive tax enforcement regimes and potential legislation changes. With the potential for US tax reform, upcoming implementation of the EU's Anti Tax Avoidance Directives and Brexit, overseeing corporate taxes may be front and center for audit committees.
Tax oversight can seem overwhelming. So how can directors fulfill their oversight role effectively and efficiently in this complex and critical area?
To learn more about the factors contributing to an increased focus on corporate taxes and what audit committee members can do to sharpen their tax function oversight, refer to PwC's Audit Committee Excellence Series: Overseeing taxes in a new era.