In this two-part conversation, public accounting experts from the CPA firm Wolf & Company provide insights on current trends in public company compliance. In our second conversation, we discuss accounting standards changes and other audit committee related topics with Jim Kenney, Scott Goodwin and Dan Morrill from Wolf.
The Podium: Hello, everyone. Thank you for joining us. In today’s discussion, we wanted to address the major trends you see coming to public company accounting in the near term. Let’s start with revenue recognition. A brand-new standard has been issued for public companies. What does it entail, and when will it be coming?
Scott: That’s right. The new standard, which goes into effect in 2018, accomplishes several objectives. It removes inconsistencies and weaknesses in existing revenue recognition guidance and provides a more robust framework for addressing revenue issues. It also provides, for the first time, a single revenue recognition standard that will be applicable across entities, industries, jurisdictions and capital markets, and provides more useful information to users of financial statements through improved disclosure requirements. One good thing is the rules are now all in one place.
As companies prepare for the new standard, audit committees should be asking about their companies’ implementation plan and methodology. There are two options for implementing the standard. One is retrospective that would require a company to restate the two years prior to 2018. Under the second option, a company would begin implementation in 2018 but would not be required to restate 2016 and 2017. However, there are certain disclosures companies will need to make in order to explain that 2018 is not comparative to 2016 or 2017.
The Podium: So the message is that companies need to be working on this now, even though it won’t be implemented until 2018?
Scott: Exactly. Boards should be asking their finance departments what is being done now to prepare for the standard. Also, when feasible, companies should reach out to others within their industry and coordinate to make sure they are thinking about the standard in the same way. They should be consulting their auditors, as well.
The Podium: Have there been any surprises in how companies are implementing the standard?
Scott: The biggest surprise is that many registrants haven’t begun to look at this closely. Most seem to be waiting as long as possible, with the hope of seeing how others implemented it. If you’re one of those registrants with their fingers crossed, hoping for a reprieve of time through a further extension of the effective date, that’s not a good strategy.
The Podium: Another new standard deals with leases. Can you talk about that?
Dan: Sure. It will be effective for 2019. Most significantly, what will happen is all operating leases, which are currently expensed and off the balance sheet, will need to be added to the balance sheet as an asset and liability. This could impact decisions on whether to lease or buy equipment or property.
The Podium: Does this have any effect on sale-leaseback transactions?
Dan: It certainly could. Sale-leaseback transactions were quite common as a method for companies to deleverage their balance sheets. Those transactions won’t go away, necessarily, but the real benefits of the transaction will be gone. It can also impact metrics such as the current ratio.
The Podium: What are some reasons this could be important?
Jim: Many companies have bank debt, and that debt has financial covenants. Some of these include leverage ratios such as maintaining a certain current ratio, where adding large assets or liabilities, even in the same amounts, could change the ratio significantly. Depending on the impact, that could result in covenant violations associated with the debt.
The Podium: So what should companies be doing to prepare for this change?
Dan: At the very least, they should talk to their bankers, because the financial statement covenants are derived from financial statements governed by generally accepted accounting principles (GAAP), and what is now GAAP will change with the implementation of the new standard. That means the covenants may need to change, as well. It’s really going to alter the look of the balance sheet.
The Podium: That gives us a good feel for accounting standard changes that are in the works. Another item companies deal with is restatement of the financial statements. What trends are you seeing there?
Jim: When we were at the SEC conference in December, the SEC said a number of restatements were related to the statement of cash flows. A primary reason given for that is that the cash flow statement is often seen as less significant than the income statement or balance sheet. As a result, it isn’t given as much attention, and often, a less experienced individual will be assigned primary responsibility for it. The cause for the restatement tends not to be a material omission but rather that a material item ends up in the wrong place on the statement.
The Podium: Fraud is another high-profile issue. What questions do you ask boards to assess their level of fraud control and preparedness?
Jim: We ask questions of boards in a few areas to determine the extent of their oversight. For example, how effective is their hotline? Do they have any areas of concern with respect to fraud in the financial statements? How do they feel about the competency of their management team in the accounting area? How are related party transactions identified, authorized and monitored? Sometimes, the audit committee isn’t prepared to answer these questions – or hasn’t thought enough about them. We then ask if they have any areas of particular concern. The audit committee should already be thinking about those areas before they respond to us.
The Podium: Thank you, everyone. We have really appreciated these conversations. We look forward to speaking with you again soon.