What private companies can learn from public companies’ implementation of Accounting Standards Update No. 2014-09

As 2019 winds down and private companies are finalizing the implementation of the new guidance, there are several things that can be learned from public companies’ implementation. Below is a brief overview of the standard and the main issues and areas of focus that public companies noted were where a significant portion of time was spent during implementation.

Capturing all contracts and assessing impact.

Capturing all contracts and assessing impact. As required by the five-step standard, you must consider all revenue streams and how the steps apply to each one. As a refresher, the five steps are below:

  1. Identify the contract
  2. Identify performance obligations
  3. Determine the transaction price
  4. Allocate the transaction price
  5. Recognize revenue

Of these steps, identifying the performance obligations and allocating the transaction price have been where most public companies have spent their time.

For instance, performance obligations must be determined, and depending on those determinations, the new standard could impact timing of when revenue is recognized, especially if those performance obligations have no standalone selling price. Identifying performance obligations could vary from company to company. For example, for many healthcare contracts, there is a single performance obligation—i.e. a bundle of healthcare services to treat a patient’s diagnosis. While the patient may receive benefit from individual services provided during the continuum of care, those services generally are integrated and are part of a bundle of services that represents the combined output for which the patient has contracted. Each service is highly dependent/highly interrelated.

Companies must assess if changes to a contract represent a new contract or a modification of an existing contract. The difference could affect how revenue is recognized over the term of that contract. For example, if an additional service is provided to a patient, is that additional obligation distinct and does it reflect a standalone selling price? If so, that additional service may be considered a separate contract. If it is not distinct or does not reflect a standalone selling price, this may be a contract modification that either modifies the original contract or may result in termination of the original contract and the formation of a new contract.

When assessing the transaction price of a contract, you must consider credit risk on the front end. Many companies would record revenue at the gross amount and consider writing off any uncollectible balances after the contract is complete and final billings have been done or after the balance has aged out a certain number of days. Under the new standard, however, these credit risk considerations must be done at the time revenue is recorded based on historical collections analysis and then incorporated into the transaction cost. For healthcare companies, there is a practical expedient that allows a portfolio approach to be used to account for patient contracts as a collective group rather than individually. Examples of the groupings within the portfolio can be based on 1) type of service (inpatient, outpatient, skilled nursing, etc.), or 2) type of payors (commercial, governmental, self- pay, etc.).

Before a company can begin implementing changes due to ASC 606, consideration of each revenue stream and how the new standard may impact the recognition of those revenue streams must be assessed. Each of the five steps must be reviewed during implementation, and documentation should be created to walk through each step.

Re-evaluating internal controls and processes.

Re-evaluating internal controls and processes. Regardless of the industry, one inevitable effect of the new standard is assessing your company’s controls and processes around revenue recognition to ensure all aspects of the contracts are being captured. This must be done after all performance obligations are considered to ensure the transaction price is being allocated accordingly.

By referencing public filings, look at internal control processes for public companies in your industry to see how they’ve had to change their processes and controls in order to capture the relevant information (performance obligations, transaction price, etc.).

While looking back at the implementation process, most of the financial reporting accountants from public companies we talked to agreed that while the impact to net revenue was not significant, the implementation process was more time-consuming than expected. There were numerous trainings held throughout the year leading up to the implementation to make sure their internal controls are adequately capturing and their financial reporting is accurately reflecting any changes identified from the ASC 606 implementation. Other financial reporting accountants discussed how they noticed changes on the front end when the standard was first adopted – for instance, different accounts being used now such as “Implicit Price Concessions” vs “Bad Debt Expense” and how those accounts are now mapped differently on the income statement.

Internal auditors agreed that most of the work is on the front end – making sure any changes required as a result of ASC 606 is being captured in the internal control processes. Changes could vary depending on the industry and what was determined when assessing the five steps for each revenue stream (transaction price, performance obligations, etc.). It was noted that while many public companies had minimal income statement impact as a result of the adoption of this standard, there was significant time incurred to arrive at that conclusion as well as significant time devoted to gathering the information needed for drafting the necessary disclosures.

Your processes and controls will have to be revised to ensure all relevant data is captured. Use this opportunity to streamline processes and make sure your team is prepared/trained.

Disclosures.

Disclosures. Since financial statement disclosures will inevitably change after implementation, take advantage of the public companies in your industry by reading through those 10-k’s and other public company filings.

Review quantitative information in that public company’s footnote, and make sure any similar information has been captured in your internal controls and processes. In addition, review qualitative information from that footnote and ensure contracts have been evaluated for key components (will a portfolio approach be used, are all performance obligations within customer contracts have a duration of one year or less, etc.). While private companies have fewer disclosure requirements, reviewing public company filings is a great place to start. As an example, some of the disclosures that are required for public companies but not for private companies are 1) disclosure of the amount of current period revenue included in any opening contract liability balance, and 2) disclosure of the judgments used to determine the amount of costs incurred to obtain or fulfill a contract as well as disclosure of the amortization method used for those contract costs.

While speaking with financial reporting managers of public companies, they noted it did take more time than they had anticipated to gather the information needed for the required disclosures. There was time spent with their internal IT teams to ensure the correct reports could be run from their systems. For example, reports had to be run for the current and prior years related to certain types of revenue streams in order to properly disclose the impact of adoption.

When preparing financial statements under the new standard, leverage the work of public companies by considering their disclosures and determine what can be utilized in yours.

While the implementation of 606 could seem daunting, there are valuable takeaways that can be learned from public companies’ implementations over the last year. Private companies can benefit from lessons learned and the “what we wish we had known” from public companies.