Accounting topics usually do not show up on the radar, especially in times when other news topics are red hot. There is, however, a conceptual transition worth noting with wide ramifications.
Good accounting is not just desirable; it is vital. Business and the general public require the best possible financial information in order to transact and invest in confidence.
Regardless, it makes sense for the cost of accounting changes to favorably correlate with the benefits. For example, spending a fortune to analyze or report on an obscure, immaterial activity is hardly a sound course of action. A cost vs. benefits standard should be applied when a widespread accounting change is entertained.
The largest accounting change in the last 10 years (perhaps one of the largest ever) is underway. It’s ASC 606. ASC stands for Accounting Standards Codification and is the source for what is commonly known as Generally Accepted Accounting Principles (GAAP). 666 might be a more appropriate code number.
The key objective of 606 is to create consistency for reporting revenue across all industries for customer contracts. Current GAAP is more industry specific. This amounts to a transition to a one-size-fits-all approach from one which recognizes unique business practices.
There is much to say about the benefits of consistency, but plain vanilla does not necessarily deliver the disclosure the public needs in an increasingly complex world.
If anything, ASC 606 increases the complexity of evaluating customer contracts by requiring revenue determination at various points in time. Basically, the economic substance of the affected contracts remains the same, so it is mainly a matter of timing of when the revenue hits the books.
OK, not so bad, but the current method has been working well for a long time. (A side note: the Enron-type disasters of the past were due to lax compliance with internal controls. No change in revenue recognition principles will prevent a recurrence. The objectives of ASC 606, as well as any other accounting change, are not intended to address fraud, abuse or lack of due diligence).
Is 606 worth it? The benefits are arguable. And for all the talk about consistency, some industries are exempt from the scope! Eventually, it is likely other exemptions will be made. After all, industries and products are not static.
Companies have and will incur significant costs to implement it. The sad part is no one really knows how much. There is no national tracking tool in place.
My guesstimate of the price tag is based on the ratio of accounting, IT and auditing costs to revenue, roughly 5%. The aggregate revenue for S&P 1500 companies is $13 Trillion, so it works out to around $65 Billion, or about $43 Million per company, if you figure that major conversion efforts require an equivalent of around 10% of the 5%. The cost will be disproportionately worse for smaller companies, and probably even worse for nonpublic firms.
Companies can make substantial improvements to reporting and control systems for that kind of money, improvements which can provide greater protection and quality of information to the shareholders and stakeholders than playing with the timeline for revenue recognition.
The Financial Accounting Standards Board (FASB) purports to consider the cost to the private sector of its decisions, but it missed the boat here. One author even suggested that ASC 606 was pushed forward to justify FASB’s efforts in the wake of its failed attempt to converge US GAAP with International Financial Reporting Standards – an objective that grew out of the Norwalk Agreement of 2002, the inspiration for 606.
Fourteen years of futility comes at a pretty high price…and difficult to explain when you have little to show for it! Reminds me of DWP’s decision to implement its new billing system rather than man up to the public and admit it would be a disaster.
The conversion, which for the largest companies started ramping up in earnest a couple of years ago, will run through 2017. The implementation date is in 2018 (2019 for nonpublic companies). Afterwards, addressing post-implementation glitches will undoubtedly cost a bundle. As cousin Eddy told Clark Griswald in Christmas Vacation about the Jelly-of-the-Month Club,”Clark, it’s the gift that keeps on giving the whole year through.”
In this case, years to come…and as useful a gift as fruit cake.