More than 18 months have passed since most registrants to the Securities and Exchange Commission (SEC) began adhering to new revenue recognition rules known as ASC 606, and the change took affect for private companies earlier this year. Meanwhile, the SEC has proposed changes to requirements related to M&A transactions and continued the debate surrounding disclosures related to a company's effect on the environment.
To find out how registrants are handling these complex issues, Toppan Merrill commissioned Mergermarket to speak with three leading experts on SEC disclosure policies for their insights.
Toppan Merrill question: The SEC’s new revenue accounting standard came into effect more than a year ago, and dozens of companies have corresponded with the Commission about its implementation. In your practice and to your knowledge, what have been the biggest flash points when it comes to the new rule? And on the shareholder side, what has the reaction been? Leading industry experts weigh in...
Andrea Basham, Cleary Gottlieb: It was an important year for many of our clients in 2018 because of the new standard – we spent a lot of time with clients walking them through the changes and explaining how to approach their financial disclosure. Although we are not accountants, as lawyers we are still always in the weeds in assisting with interpretation of new standards, and also in advising on related qualitative disclosure issues.
For example, companies are very focused on ensuring that investors understand the changes and don't interpret them the wrong way. Companies are also providing a lot more disclosure regarding how they make their determinations under the new standard than they have in the past.
One thing we and I think our clients appreciated about the process in 2018 in the run-up to adoption of the standard was the level of interaction with the Commission. If you look at the SEC comments that came out after some of the first companies incorporated the standard, they were consistent in a way that gave us and our clients comfort that we were interpreting the standard correctly. We were able to look at comments issued previously in a given industry and help clients preemptively make adjustments to their disclosure, which I think facilitated the process and made the time period during which companies could have been subject to back-and-forth communication with the SEC much shorter.
SEC staff also made themselves available to answer questions preemptively, in order to avoid comments down the road.
Amisha Shrimanker Kotte, Jones Day: In speaking with clients as they were preparing for the new accounting standard, one of the biggest flashpoints was obviously the impact the change would have on their internal systems and processes. For example, salespeople may need to be trained in how to think about contracts and performance obligations under the new standard. I think in some ways that was an underappreciated aspect of the change. Companies also needed to think about any impact on their compensation structures or compliance with their debt covenants based on the new standard. In leading up to implementation, lining things up internally was a major focus.
One result of the new standard has been a significant increase in the amount of information companies are releasing about their revenue activities. This is mainly because the standard relies heavily on estimates and judgements, and inevitably that requires more extensive disclosure on the judgments being applied. Companies need to explain their approach to the new standard, and I think you can certainly see that as a response to some of the comment letters issued by the SEC. The staff wants to know why they chose the approach they did, what assumptions they were making, and what processes were followed.
In terms of specific areas of focus by the SEC, the identification of what was going to be considered a performance obligation became an important issue. The staff wanted to understand how companies determined the purchase price, along with its allocation, and how a company would then measure when it would actually recognize revenue. For example, the SEC wanted to understand why a company would note a contract had one performance obligation if the contract included multiple goods and services.
For the most part, companies tried to be clear about these issues without going overboard in their disclosure. For shareholders, the purpose was to provide greater transparency, along with a way to compare revenue across multiple industries. It may take time for investors to understand how these new disclosures align with the other disclosures a company makes including within a 10-K since reviewing revenue disclosures may not fully align with how a company talks about its business segments.