Revenue Recognition: SAB 74 Disclosures

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1 The U.S. Securities and Exchange Commission s (SEC) Staff Accounting Bulletin No. 74, (SAB 74) Disclosure of the Impact That Recently Issued Accounting Standards Will Have on the Financial Statements of the Registrant When Adopted in a Future Period, imposes financial statement disclosure requirements in advance of a company s adoption of a new accounting standard. The next several years will see a flurry of major accounting changes primarily related to three recently issued standards: Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers; ASC 842, Leases; and ASC 326, Financial Instruments Credit Losses. In several speeches, SEC officials have made it clear they are looking for increasing levels of detail from SAB 74 disclosures as the effective dates approach. For public entities 1, the revenue rules are effective for calendar-year 2018 financial statements. Let s take a closer look at the SEC s expectations for SAB 74 disclosures related to adoption of the new revenue recognition standard, Accounting Standards Update (ASU) In multiple public speeches, senior SEC officials noted they are looking for disclosures beyond the plain language of SAB 74. Statements that the effect of the new standard is immaterial should reflect consideration of the full scope of the new standard, which covers recognition, measurement, presentation and disclosure for revenue transactions. The SEC staff expects to see the following in the upcoming SAB 74 disclosures (whether in the Form 10-K or quarterly reports on Form 10-Q): Quantitative disclosures of directional effects of adoption, if known, and the anticipated date and method of adoption (in the case of revenue recognition, full versus modified retrospective) (see Ford, Appendix A) Qualitative information on the status of management s implementation efforts (see AT&T, Appendix B) Any additional information whether quantitative or qualitative that may be necessary to enable investors to understand the company s progress on implementation (see Analog Devices, Appendix C) Enumeration of open items not yet addressed as part of a company s implementation plan (see Microsoft, Appendix D 2Q17) Quantitative estimates of the effects on specific product categories or revenue streams if reasonably determinable, even if the overall revenue effects are not yet calculable (see Microsoft, Appendix E 1Q17) From a preliminary look at recent Form 10-K and Form 10-Q filings, a number of companies have enhanced their transition disclosures, although others still have more work to do. Some recent SEC filings include these SAB 74 details: The expectation of more, less or similar performance obligations and whether revenue would be recognized earlier, later or remain the same (see Fluor, Appendix F) The possibility of earlier revenue recognition for contingent amounts of variable consideration (see Morgan Stanley, Appendix G) The need to recognize revenue later for certain contracts that were previously recognized over time using the percentage-of-completion model (see Howard Hughes Corp., Appendix H) 1 The new revenue standard defines a public entity as any one of these: A public business entity A not-for-profit entity that has issued, or is a conduit bond obligor for, securities traded, listed or quoted on an exchange or over-the-counter market An employee benefit plan that files or furnishes financial statements to the SEC

2 The SEC recognizes that SAB 74 disclosures are preliminary and subsequent changes in disclosed estimates will not be assumed to reflect a control deficiency relating to prior disclosures. A company s disclosures should evolve over time and be consistent with information provided to its audit committee and investors. As management completes portions of its implementation plan and develops an assessment of the anticipated effect, effective internal controls should be designed and implemented to timely identify disclosure content and ensure that appropriately informative disclosure is made. The SEC announced it will pay close attention to both the accounting policy footnote addressing the effect of adoption of the new generally accepted accounting principles and a company s quarterly disclosures of any material changes to internal controls over financial reporting, given the magnitude of the implementation process. SEC officials emphasized that audit committees should be discussing the outside auditor s views about management s implementation efforts. Wesley Bricker, SEC chief accountant, pointedly observed in his American Institute of CPAs keynote address: Particularly for companies where implementation is lagging, preparers, their audit committees and auditors should discuss the reasons why [implementation is lagging] and provide informative disclosures to investors about the status so that investors can assess the implications of the information. Successful implementation requires companies to allocate sufficient resources and develop or engage appropriate financial reporting competencies. BKD continues to monitor the revenue recognition standard process. Visit BKD's Hot Topic page to learn more. Contributor Anne Coughlan Director acoughlan@bkd.com 2

3 Appendix A Ford Motor Company K We will adopt the new revenue guidance effective January 1, 2017, by recognizing the cumulative effect of initially applying the new standard as an increase to the opening balance of retained earnings. We expect this adjustment to be less than $100 million, with an immaterial impact to our net income on an ongoing basis. Adoption of the new standard will also result in changes in classification between Revenues, Cost of sales, Non-Financial Services interest income and other income/(loss), net, and Financial Services other income/(loss), net. Appendix B AT&T K Upon initial evaluation, we believe the key changes in the standard that impact our revenue recognition relate to the allocation of contract revenues between various services and equipment, and the timing in which those revenues are recognized. We are still in the process of determining the impact on the timing of revenue recognition and the allocation of revenue to products and segments. ASU also specifies that all incremental costs of obtaining and direct costs of fulfilling our contracts with customers should be deferred and recognized over the contract period or expected customer life. In the third quarter of 2015, we changed our accounting policy for the costs of fulfilling contracts with customers to defer all recoverable costs while not changing our approach to acquisition costs. We believe, as a result of our accounting policy change for fulfillment costs, that the requirement to defer such costs in the new standard will not result in a significant change to our results. The requirement to defer contract acquisition costs however, will result in the recognition of a deferred charge on our balance sheets, but as the industry continues to undergo changes in how devices and services are sold to customers with impacts on the resulting commissions paid to our internal and external salesforces, we cannot currently estimate impact of this change. While we continue to evaluate the impact of the new standard and available adoption methods, we believe the standard will require us to implement new revenue accounting systems and processes, which will significantly change our internal controls over revenue recognition. Appendix C Analog Devices 1Q17 10-Q We have developed a project plan for the implementation of the guidance including a review of all revenue streams to identify any differences in the timing, measurement or presentation of revenue recognition. While the Company is still in the process of completing its evaluation of the standard, it currently believes the most significant impact will be related to the timing of recognition of sales to distributors. The Company currently defers revenue and the related cost of sales on shipments to distributors until the distributors resell the products to their customers. Upon adoption of ASU , the Company will no longer be permitted to defer revenue until sale by the distributor to the end customer, but rather, will be required to estimate the effects of returns and allowances provided to distributors and record revenue at the time of sale to the distributor. The Company is continuing to evaluate the future impact and method of adoption of ASU and related amendments on its consolidated financial statements and related disclosures. The Company is considering early adoption of the new standard using the full retrospective method in the fiscal year ending November 3, The method of adoption and the Company's ability to early adopt the standard is dependent on system readiness and the completion of analysis necessary to meet the requirements under ASU

4 Appendix D Microsoft 2Q17 10-Q We currently anticipate early adoption of the new standard effective July 1, While our ability to early adopt using the full retrospective method is dependent on system readiness, including software procured from thirdparty providers, and the completion of our analysis of information necessary to restate prior period financial statements, we remain on schedule and have implemented key system functionality to enable restated financial information. Our progress includes nearing completion of retrospectively adjusted financial information for fiscal year We anticipate this standard will have a material impact on our consolidated financial statements, and continue to make progress in assessing all potential impacts of the standard, including any impacts from recently issued amendments. We have reached conclusions on all key accounting assessments related to the new standard. However, we are still assessing impacts from guidance issued by the FASB Transition Resource Group as part of their November 2016 meeting. We will continue to monitor and assess the impact of changes to the standard and interpretations as they become available. We have also started our assessment to determine the revenue recognition impact of our recent acquisition of LinkedIn. The most significant impact of the standard relates to our accounting for software license revenue. Specifically, under the new standard we expect to recognize Windows 10 revenue predominantly at the time of billing rather than ratably over the life of the related device. We expect to recognize license revenue at the time of contract execution rather than over the subscription period from certain multi-year commercial software subscriptions that include both software licenses and Software Assurance. Due to the complexity of certain of our commercial license subscription contracts, the actual revenue recognition treatment required under the standard will be dependent on contract-specific terms, and may vary in some instances from recognition at the time of billing. We expect revenue recognition related to our hardware, cloud offerings including Office 365, and professional services to remain substantially unchanged. We continue to believe that the net change in Windows 10 revenue from period to period is indicative of the net change in revenue we expect from the adoption of the new standard. Appendix E Microsoft 1Q17 10-Q We currently anticipate adopting the standard using the full retrospective method to restate each prior reporting period presented. We currently anticipate early adoption of the new standard effective July 1, Our ability to early adopt using the full retrospective method is dependent on system readiness, including software procured from third-party providers, and the completion of our analysis of information necessary to restate prior period financial statements. We anticipate this standard will have a material impact on our consolidated financial statements. While we are continuing to assess all potential impacts of the standard, we currently believe the most significant impact relates to our accounting for software license revenue. We expect revenue related to hardware, cloud offerings, and professional services to remain substantially unchanged. Specifically, under the new standard we expect to recognize Windows 10 revenue predominantly at the time of billing rather than ratably over the life of the related device. We also expect to recognize license revenue at the time of billing rather than over the subscription period from certain multi-year commercial software subscriptions that include both software licenses and Software Assurance. Due to the complexity of certain of our commercial license subscription contracts, the actual revenue recognition treatment required under the standard will be dependent on contract-specific terms, and may vary in some instances from recognition at the time of billing. We currently believe that the net change in Windows 10 revenue from period to period is indicative of the net change in revenue we expect from the adoption of the new standard. 4

5 Appendix F Fluor K Management is currently evaluating the impact of adopting ASU , , , and on the company's financial position, results of operations, cash flows and related disclosures. Adoption of these ASUs is expected to affect the manner in which the company determines the unit of account for its projects (i.e., performance obligations). Under existing guidance, the company typically segments revenue and margin recognition between the engineering and construction phases of its contracts. Upon adoption, the company expects that the entire engineering and construction contract will typically be a single unit of account (a single performance obligation), which will result in a more constant recognition of revenue and margin over the term of the contract. The company will adopt ASU during the first quarter of The company expects to adopt this new standard using the modified retrospective method that will result in a cumulative effect adjustment as of the date of adoption. Appendix G Morgan Stanley K We will adopt the guidance on January 1, 2018 and are currently evaluating the method of adoption. We expect this accounting update to potentially change the timing and presentation of certain revenues, as well as the timing and presentation of certain related costs, for Investment banking fees and Asset management, distribution and administration fees. Outside of Investment Management performance fees in the form of carried interest, these changes are not expected to be significant. Regarding the recognition of performance fees from fund management activities in the form of carried interest that are subject to reversal, there are alternative views in the industry which include consideration as to whether these arrangements are in the scope of the new revenue guidance or are financial instruments under the scope of equity method of accounting. If we follow the equity method of accounting principles, the current recognition of such fees would remain essentially unchanged. If the fees are deemed in the scope of the new revenue guidance, we would defer recognition until such fees are no longer subject to reversal, which would cause a significant delay in the recognition of these fees as revenue. We are currently assessing the alternative accounting approaches and continue to closely monitor developments in this still-evolving area. We will continue to assess the impact of the new rule as we progress through the implementation of the new standard; therefore, additional impacts may be identified prior to adoption. Appendix H Howard Hughes Corporation 1Q17 10-Q We have concluded that after adoption we will not be able to recognize revenue for condominium projects on a percentage of completion basis, and generally revenue will be recognized when the units close and the title has transferred to the buyer. We are continuing to evaluate the new guidance to determine any other impacts on our consolidated financial statements. 5