For the Investor
By Marc Siegel, FASB Member
Investor Influence in New Accounting Standards
In a recent column, I highlighted several new accounting standards which could be reflected in financial statements in 2018. In each of these new rules, investor feedback played a part in influencing what gets reported in the financial statements, what gets disclosed, or both.
Investor feedback played a part in influencing what gets reported in the financial statements, what gets disclosed, or both.
In this article, I will explore the feedback investors provided us specifically on Revenue Recognition and Defined Benefit Pension Plans. This feedback was crucial, as the FASB created two accounting standards that produced financial information useful in helping investors decide:
- Whether to provide resources to a company, and
- Whether the management of that company has made good use of the resources it already has.
Throughout the development of the newly effective Revenue Recognition standard, investor outreach helped inform FASB and International Accounting Standards Board (IASB) staff and Board Members as they formulated cost–benefit opinions.
Throughout the development of the standard, investor outreach helped inform FASB and IASB staff and Board Members as they formulated cost–benefit opinions.
For example, Step 3 of the revenue standard includes determination of the transaction price. While in many cases this will be straightforward, in some situations there will be contingent pricing or price guarantees for items sold through a distribution channel. For circumstances such as these, the Boards could have opted to require companies to fully estimate the transaction price at the start of the contract, wait until the price is fully fixed or determinable, or make an estimate on Day 1 but constrain it in a way that revenue is not reversed later due to the contingency.
Investors provided feedback that in many cases revenue reversals in a quarter would be difficult to interpret and much harder to project into the future for modeling purposes. As such, the Boards decided to constrain the estimate of the transaction price such that it’s probable that there wouldn’t be a revenue reversal.
The changes to required disclosures were a direct effect of investor feedback through global investor and preparer workshops. The investors informed us of the items which would be very helpful in their analysis, and a sense of their relative priority. In turn, preparers heard this feedback and it helped them and the Boards understand the difficulties and costs of these items. This dynamic helped Board Members develop their opinions about the relative cost and benefit of certain requirements.
One example of a compromise is the disclosure requirements around contract assets and liabilities (such as deferred revenues). While the investors stated a preference for a full rollforward disclosure of contract assets and liabilities, the preparers noted that rollforwards often entail significant costs, because the changes in the balances must be fully reconciled in the preparation of a rollforward.
The Boards’ ultimate decision was to disclose quantitatively the significant changes in the balances of these items rather than a full rollforward. This decision should provide investors with important information and reduce preparer costs by allowing them to focus on the material changes, rather than reconciling immaterial changes.
For example, rather than presenting a full and potentially costly full rollforward of deferred revenues, companies instead are required to present the amount of deferred revenue recognized during a period that was included in the deferred revenue balance at the beginning of the period as well as any non-routine changes in the deferred revenue balances.
Defined Benefit Pension Plans
As an analyst that took deep dives into financial statements and footnotes, I spent a lot of time digging into disclosures about pension plans.
Almost all investors agree that more transparency about how and where pension accounting impacts the income statement is necessary.
Regularly, I was asked by investors if I could answer a “quick” question about pension accounting. Unfortunately, there were no quick answers as there are many dimensions to analyze. While defined benefit pension plans wane in importance as part of the overall compensation and retirement benefits provided to employees, the effects of pension accounting can significantly impact reported operating results of many companies to this day.
Since joining the FASB, I noticed that stakeholders have provided mixed views as to whether the Board should overhaul pension accounting rules. However, almost all investors agree that more transparency about how and where pension accounting impacts the income statement is necessary.
Many informed us about a significant obstacle to their understanding of pension accounting today. They told us that some companies choose to reflect actuarial gains/losses over time, while others choose to adjust immediately for all aspects of pension accounting. However, in both cases, all the pension costs today are aggregated together and included within operating income at companies that present it.
To further improve GAAP, we need to hear directly from you about the kind of information you need.
As such, we issued a new standard, which goes into effect in 2018, that affects companies that report an operating income subtotal on their income statement. For those companies, only service cost can be included within the line items making up that subtotal. The other components of pension cost will be shown separately, outside of the operating income subtotal. This rule should somewhat ease the comparability differences for companies which report operating income for their pension activities.
As you can see, feedback from investors often helps the Board in their efforts to judge costs and benefits. To further improve GAAP, we need to hear directly from you about the kind of information you need. This input will help the FASB set standards that result in better information for investors and other users of financial reports.