Implementation of the new revenue recognition standard

July 5, 2017

A blog post by Amy Steele, Audit & Assurance partner, Deloitte & Touche LLP, National Office Audit & Assurance Services*

The new revenue recognition standard is a huge implementation effort for many companies, and it is important that it gets done right. It shouldn’t be said at this point—less than six months prior to the effective date for public calendar-year-end companies—that the effect is still unknown. Companies should be getting closer to the robust and quantitative disclosures that the SEC expects. Auditors can and should be onboard during this assessment and early implementation phase. Companies should involve their auditors to achieve effective implementation and quality financial reporting.

Not only do I think that an approach of “taking your auditors along for the journey” can improve the quality of financial reporting and the quality of audits, I also think that it is a necessary element of our audit. I will focus on two main areas where this is particularly important in the pre-adoption period: (1) Staff Accounting Bulletin No. 74 (SAB 74, Topic 11.M) transition disclosures and (2) internal controls over the adoption of the new revenue recognition standard.

Transition Disclosures
SAB 74 (Topic 11.M) requires that companies provide transition disclosures to investors of the impact that a recently issued accounting standard will have on its financial statements when that standard is adopted in a future period. The SEC staff have expressed the expectation that such disclosures include a description of the effect of the accounting policies that the company expects to apply, if determined; a comparison with the current accounting policies; the company’s progress in implementing the new standard; and the significant implementation matters that it still needs to address. The SEC staff have also expressed the expectation that the transition disclosures become more robust and quantitative in nature as companies get closer to the effective date of the standard. Auditors audit the company’s annual financial statements taken as a whole, which includes disclosures.

Assuming companies take the direction given by the SEC staff and provide robust and quantitative transition disclosures in their annual financial statements, it could be a significant undertaking for auditors. As part of an audit, auditors obtain an understanding of the company's selection and application of accounting principles, including related disclosures and evaluate whether the company's selection and application of accounting principles are appropriate for its business and consistent with the applicable financial reporting framework and accounting principles used in the relevant industry. Additionally, depending on the significance of the transition disclosures and the risks of material misstatement related to the disclosures, auditing such disclosures could require auditors to evaluate the significant accounting conclusions underlying the disclosures and may also require auditors to perform audit procedures on the underlying transactions. Given this potentially significant scope of work, it is important for auditors to work with management early in the process to understand management’s plans for disclosure and the associated timeline and evidence to support the disclosures. Auditors should also plan the nature and scope of their work in this area, which could be significant.

Internal Controls
The Sarbanes-Oxley Act of 2002 added a requirement for most public companies that management annually assess and report on the company’s internal controls over financial reporting (ICFR) and also requires that for most large public companies their auditors attest to management’s assessment of the effectiveness of its ICFR (“audit of ICFR”). Most companies follow the COSO framework for internal controls. Under the COSO framework, there are five interrelated components to internal control. One component is the control environment, which comprises the following principles:

• Integrity and ethical values of the organization,
• Framework enabling the board of directors to carry out its oversight responsibilities,
• Organizational structure and assignment of authority and responsibility,
• Commitment to attracting, developing, and retaining competent individuals, and
• Monitoring of accountability for performance.

The control environment has a pervasive impact on the overall system of internal control, and an effective control environment is important in a time of significant accounting change.

The following considerations related to four of the COSO principles are particularly relevant during the implementation of a new accounting standard:

• Principle 1—Has the entity demonstrated an appropriate tone at the top regarding the importance of the adoption of the new accounting standard?
• Principle 2—Does the board of directors exercise oversight of the development of internal controls related to the adoption of the new accounting standard?
• Principle 4—Has the entity identified competent individuals to implement the new accounting standard?
• Principle 5—Does the entity hold individuals accountable for their roles related to the adoption of the new accounting standard?

If auditors are not along for the journey, it could be challenging for them to assess this critical area as part of the audit of ICFR.

Effective implementation requires focus and effort by a variety of players, including companies, audit committees, and auditors. Much of the focus to date has been on companies. We need to also focus on auditors. The auditor’s role is important for effective implementation of new accounting standards, including the new revenue recognition standard.

What do you think the auditor’s role is in implementation? Are there other areas that auditors should be focusing on during the implementation period?

*Note: The views expressed in this blog are those of the blogger and not official statements by Deloitte Touche Tohmatsu Limited or any of its member firms, including Deloitte & Touche LLP.