Integra Audit & Accounting Alert

Revenue Recognition Revisited

Standardization of revenue accounting comes with complexity

When Integra’s Audit & Accounting Committee met in November to discuss the recently adopted revenue accounting pronouncement, a common theme among the globally represented group was that the complexities of the standard demanded considerable attention from public accountants and their clients to assure accurate implementation. Since private companies were generally required to employ the new provisions as of the 2019 calendar year, this meeting was timed to allow those present to reflect on their experiences and share issues encountered during the rollout. Jim Rose, CPA, partner with Integra member firm, Abeles and Hoffman, P.C. in Saint Louis, Missouri, USA, ably led the discussion, and also provided a Revenue Recognition Analysis Tool that his firm uses to facilitate the process.

First on the agenda was a quick review of the five-step revenue recognition process that, basically, is designed to determine “an amount that reflects the transfer of goods and services to customers that corresponds to the consideration it expects to be entitled to in exchange for those goods and services.”

The five steps that must be met are:

Identify the contract with a customer - A contract must be approved and have identifiable rights, payment terms, commercial substance, and probability of collecting payment.

Identify performance obligations of the contract - distinctive goods or services must be identified.
Determine the transaction price - A calculation must be made of consideration to be given, allowing for estimates of variable amounts, time value of money, non-cash items, and customer allowances.
Allocate the transaction price to the appropriate performance obligations of the contract - Apportionment of the consideration must take into account individual characteristics of each performance obligation.

Recognize revenue when (or as) the performance obligations are satisfied - Determination must be made of when control has passed, considering indicators such as a point in time versus over a time period, and progress towards completion.

A key, but challenging aspect for auditors is the importance of maintaining an appearance of independence from their audit clients regarding the new revenue accounting standard. With the wide-ranging changes, the task of preserving appropriate objectivity requires thoughtful planning and preparation. Jim Rose spent time in the meeting reviewing the Revenue Recognition Analysis Tool that enables his firm to communicate the requirements to clients, while also requesting that they fill out a template describing their process of recognizing revenue that can be adapted to the new provisions. The completed template can then be kept in the auditor’s file as documentation of the client’s understanding and compliance.

Rounding out the independence discussion, a proposed addition to the client representation letter was presented that has the client affirming that all contracts have been properly reported and disclosed in accordance with the provisions of the Revenue from Contracts with Customers standard. The group noted that the accounting and disclosures are required regardless of whether the financial statements are compiled, reviewed or audited.
Finally, audit missteps that have come to light thus far were covered. This part of the discussion referred to a Journal of Accountancy article from July 1, 2020, titled Challenges to consider in auditing revenue recognition, authored by several staff members of the Association of International Certified Professional Accountants. In addition to independence concerns, the article warned of the following missteps:

Risk assessment – failing to “consider the client’s processes and controls related to the revenue transaction cycle,” and not obtaining “an understanding of the procedures implemented by the client to meet the requirements” of the standard.
Substantive testing – “insufficient test procedures relative to recognizing revenue where significant estimates are involved.”
Documentation - failure to follow the audit standard that requires sufficient documentation so that an auditor not connected to the audit can understand what was done, the results, and the conclusions reached.

Members of Integra’s Audit & Accounting Committee and the Integra staff can be contacted through the Integra International website.

Further details can be found at Challenges to consider in auditing revenue recognition.
(https://www.journalofaccountancy.com/issues/2020/jul/auditing-revenue-recognition-challenges-to-consider.html).