What happens when a small business fails to comply with important regulations? In the classic movie It’s a Wonderful Life, a local building and loan association is in danger of failing its bank audit because of a major—but innocent—mistake by one of its officers. Are your clients in the same kind of danger as Bailey Building & Loan?
They could certainly face unnecessary disruptions if they underestimate the impact of the significant new Financial Accounting Standards Board (FASB) revenue recognition standard and aren’t ready to tackle implementation as the rules become effective. (FASB Topic 606 is effective for nonpublic entities for annual reporting periods beginning after December 31, 2018.) Here are three lessons the movie can teach practitioners and clients before it’s too late.
Don’t count on Uncle Billy! In the movie, main character George Bailey finds himself in hot water when he incorrectly assumes his Uncle Billy will make a crucial deposit to the organization’s account. CPAs find that many clients also make incorrect assumptions about implementing FASB Topic 606. They may misunderstand the scope of the standard and the urgency in preparing for implementation, says CPA Michael Westervelt, a principal and BizOps Quality Leader at CliftonLarsonAllen, and that’s a problem. Since many smaller organizations don’t issue interim statements, they may get to the end of 2019 and realize the numbers they’ve relied on all year have to be recast. CPA David Semendinger, a partner and Quality Control Group Leader at Aronson LLC, points to the issues that will occur if third parties receive incorrect information. He warns clients, “you don’t want to give your interim financial statements to banks, owners or private equity groups throughout year, then come back to them in 2020 and tell them you’ve actually violated covenants.”
CPAs are going to have to be like Clarence. George Bailey gets help from a guardian angel named Clarence, who steps in to show him a different view of his world that changes his mindset. CPAs must also give clients a different perspective by alerting them to the standard’s impact. Aronson took many steps including creating a slide presentation that walks clients through the standard. Since the rules on performance obligations are particularly challenging, the firm has also volunteered to review one or two contracts for clients to help them understand how the standard applies. Semendinger advises that practitioners should make it personal when talking to clients, use examples that are relevant to their business and be patient and persistent.
Semendinger’s firm also advises banks, which are often unfamiliar with the standard. But once the standard and its impact on covenants is carefully explained, banks feel compelled to speak with clients about standard implementation.
Your guardian angel can’t do it all for you. CPAs should also consider and communicate the potential limits of their own role in helping the client. When creating a system for the new standard, the CPA doing an audit or a review can be part of the discussion, but can’t design the system. That would be an independence violation, notes Westervelt, who’s also the chair of the AICPA Technical Issues Committee. For that assistance, the CPA would have to recommend that the client work with a third party. Organizations that lack a properly designed system may not be able to get their financial statements audited or reviewed on time, Semendinger points out, which could also have other implications such as a delay tax returns for accrual basis taxpayers. There will be a spiraling impact if they don’t start early.
Start the conversation now
Westervelt says the standard’s impact on private companies will vary depending on their industry, how they earn revenue and other considerations. In all cases, though, “CPAs need to have a conversation with clients on how prepared they are to implement the standard and whether they have the necessary controls and system in place.” He points out that it can be a positive opportunity to reconsider the organization’s systems and adopt new approaches that will offer more timely and useful financial information.
The AICPA’s revenue recognition webpage features helpful information and valuable resources including a learning and implementation plan and a financial reporting brief discussing tax implications of the new standard. The AICPA’s Center for Plain English Accounting also provides high-quality revenue recognition information and training to its members. And for even more insight, review the FASB’s transition resource group’s revenue recognition memos and consider attending their free webcast geared toward private companies on December 18.