Some auditors believe the converged standards on revenue recognition will trigger important questions about financial reporting controls and become a significant compliance issue. The issues are important enough that the PCAOB is considering the need for providing guidance.
The FASB and IASB’s recently issued standards on revenue recognition will introduce a sea change in accounting, and the transition is expected to be challenging for both management and auditors.
“In many ways, I draw parallels to the initial implementation of [Sarbanes-Oxley Section] 404, at least in one cycle, where it will be beneficial if auditors, audit committees, and managements have a clear communication of process over the life of this implementation,” said Philip Santarelli, chief risk officer of ParenteBeard LLC, during a meeting of the PCAOB’s Standing Advisory Group (SAG) in Arlington, Virginia, on June 25, 2014. “The auditors really need to be going with them along the way to make sure they agree with the level of internal controls, testing, and methodologies.”
The FASB’s standard will eliminate an estimated 180 pieces of industry-specific revenue rules in U.S. GAAP and require companies to follow a single set of principles. The revenue guidance calls for more detailed disclosures. The boards said they also improved the accounting guidance for complex contracts with multiple elements.
The changes were adopted by the FASB in Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, and the IASB in IFRS 15,Revenue from Contracts with Customers.
The standards become effective in 2017, and companies will adjust their results from previous periods with a retrospective application.
Alison Spivey, a partner in professional practice with Ernst & Young LLP, said a company will look at its results with an entirely different lens. The changes that companies make to how they recognize revenue will affect audit planning considerations.
“We have to evaluate the risks that now arise as a result of the new accounting,” Spivey said. The revenue standard is expected to bring in significant judgment and will pose significant challenges for auditors.
For example, Spivey said a challenging area for auditors will be the type of evidence to support judgments that companies make.
“We can’t just rely on inquiry alone,” she said. “We have to be able to see documentation that exists in a company’s file and be able to corroborate that, challenge that. All the challenges we have today with auditing estimates will also be apparent with this new accounting standard as well.”
In the meantime, the PCAOB is debating what type of guidance to provide, and for now, its chief auditor said no decision has been made.
“The first thing we will think about is developing staff guidance,” Martin Baumann said. “The second thing we will be looking at is amending standards, if necessary, such as auditing estimates. And the third thing, ‘gee it’s so pervasive, and we do need a new standard.’ All options would be open. We would start off with the simplest first in our thinking.”
Even though it’s not effective in the U.S. until the first-quarter filings in 2017, Baumann said companies will have to start doing bookkeeping and internal controls for 2015. “That’s not too far away for us to think about. But you also have to consider under the IASB’s option, early adoption is permitted internationally.”
Audits of foreign companies that file with the SEC are audited under PCAOB standards, and “potentially may need this guidance sooner than later,” he said.
Some SAG members such as E&Y’s Americas Vice Chair Kevin Reilly, PricewaterhouseCoopers LLP’s Managing Partner for Assurance Quality Michael Gallagher, and former FASB Chairman Robert Herz, said the PCAOB ought to consider incorporating providing guidance to another project dealing with auditing accounting estimates because of the revenue recognition standards’ broad use of estimates.
“A standard on auditing revenue that’s going to incorporate across all of the different industries, different issues, different problems, all of the things that are going to crop up over the next several years is probably not worth the effort, and we would be better served by really fine tuning what’s gong on in auditing estimates,” Reilly said.
Herz said the regulatory board could consider giving some examples of the kinds of documentation that the inspection staff will be looking for.
Jeff Mahoney, general counsel of the Council of Institutional Investors, said he has no opinion about whether the PCAOB should issue staff guidance for the revenue standard but asked the board to consider the timing of anything it may publish.
The FASB and IASB formed a transition resource group; the SEC is expected to replace its staff guidance in Staff Accounting Bulletin Topic 13; and the AICPA has formed a task force of 16 industry areas to help accountants implement the standard.
“So would it make some sense if you are going to issue some guidance, to wait and have some of that work itself out?” Mahoney said.
He said investors will find the comprehensive disclosure that comes with the standard very important, perhaps more so than the debits and credits of numbers, and suggested the board look at implementation of disclosures.
Elizabeth Mooney, an analyst with the Capital Group Cos., said revenue reporting is very important for investors, and she encouraged the PCAOB to consider having an auditing standard specific to revenue recognition.