Revenue Rule Could Pose Challenges to Bonus, Compensation Plans

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By Denise Lugo

The 2018 revenue recognition standard could affect companies’ compensation or bonus plans because measurement methods used under the old rules will change, a senior Deloitte & Touche LLP executive told a conference May 8.

“A lot of companies have some type of bonus arrangement, compensation plan, or some type of compensation for their employees and executives and invariably all those types of plans have some sort of link to revenue,” Deloitte senior consultation partner of revenue recognition Eric Knachel said at a Deloitte and Bloomberg BNA conference on revenue recognition.

“And when those plans were put into place, whatever they were, they overlap years. You then have the question of, ‘they set up some sort of benchmark and we’re going to pay someone a bonus based on how they do against this metric'—the problem is that metric was designed based on the old rules and you basically changed how you’re going to keep score,” Knachel said.

The revenue standard is one of the biggest accounting changes in over a decade. It will impact every industry and is applicable to every company. The reach of the guidance stretches to all contracts with customers with certain exceptions.

Solution Isn’t Obvious

Companies still have the same bonus and compensation arrangements but now have to grapple with what to do with them under the new Revenue from Contracts with Customers—ASC 606—rules, Knachel said . It’s an issue some companies find confusing. “I’ve seen two approaches, both of which are not obvious,” he said.

One approach is to keep two sets of books, one under the new standard and another for purposes of the compensation plan or bonus arrangement, Knachel said. The second approach is to change the comp plan or bonus arrangement.

Neither approach is an “obvious” solution and comes with challenges and complications. “Can you do that unilaterally—there’s probably some legal implications—can you just say this was the bogey we had set up and we’re going to change that because we changed the way we’re keeping score for revenue we’re going to change the plan—not obvious how you just go ahead and do that” Knachel said. “I’ve come across this with a number of companies and it’s presented some real issues in terms of how do we deal with this.”

Knachel’s comments came among the broader implications of the new rules—legal, IT and human resources—and the potential for unforeseen issues to emerge. “If you wait to deal with that issue until later on in your implementation it becomes that much more complicated. So it kind of emphasizes to me the need to have more than just accounting involved,” he said.

Internal Controls: Think Through Fraud Risk

Adequate internal controls over financial reporting (ICFR) in making accounting judgments and disclosures are critical for moving successfully to the new standard, discussions at the conference indicated.

“As it relates to accounting judgments, there will be day-one judgments and subsequent reevaluations of those judgments, so there will need to be ICFR over both of those types of judgments,” said Sarah Esquivel, associate ahief accountant in the Securities and Exchange Commission’s office of the chief accountant. “That will likely entail robust internal documentation in various forms,” she said.

Companies should pay special attention to accounting judgments made under ASC 606 when providing the same answer as they would for the old 605 rules being superseded. “The way you’re arriving at this judgment is likely different than the way you are today, and so companies should take a fresh look at whether or not the controls they have in place are effectively addressing the risks that you have and how particular those judgments are,” Esquivel said.

For disclosures, companies should think through accuracy and completeness of data being gathered. “The extent that you already have information that’s being disclosed outside the financial statements and you decided that you’re going to pull that into your audited financial statements, that’s another area to remain focused on because the way you’re pulling that data today might need to be more robust and require stronger controls,” Esquivel said.

Companies also must consider carefully potential fraud risk because of the level of judgment the revenue rules introduce. “There’s always the potential for management bias, so just a reminder to think through whether or not you’ve appropriately identified your progress as a part of that process,” Esquivel said.

To contact the reporter on this story: Denise Lugo in Washington at dlugo@bna.com

To contact the editor responsible for this story: S. Ali Sartipzadeh at asartipzadeh@bna.com

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