Remarks before the 2016 AICPA National Conference on Current SEC and PCAOB Developments

Ruth Uejio, Professional Accounting Fellow, Office of the Chief Accountant

Washington, D.C.

Dec. 5, 2016

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission or of the author's colleagues upon the staff of the Commission.

Introduction

Good morning. As Sylvia noted earlier, I spend a large portion of my time on new revenue recognition matters, and will share some observations in that area. Additionally, I am the current lead of OCA's Non-Financial Assets (NFA) Team.[1] One of the NFA Team's key activities is the active monitoring of implementation of the new leases standard.[2]

This morning, I will touch on observations from recent consultations and monitoring activities related to:

• recognition of payments to customers;
• presentation and disclosure considerations related to the principal versus agent analysis;
• allocation of a change in PBO[3] to pension interest cost; and
• implementation activities of the new leases standard.

New GAAP: Assets and Payments to Customers

The first topic I'd like to discuss relates to accounting for payments made to customers. OCA staff's focus in this area is in connection with the transition to the new revenue recognition standard. There are many different types of business activities that can result in a company making payments to its customers. For example, a company may make an upfront payment to a new customer in order to secure an exclusive relationship with that customer, or may make a payment as part of a marketing incentive program.

I understand that these are often challenging fact patterns to evaluate in practice, and the accounting conclusions will be dependent on specific facts and circumstances. There are a number of educational resources available to companies working through issues in this area. As a starting point, resources available to all companies include guidance in the new revenue recognition standard[4] and the Basis for Conclusions,[5] other relevant GAAP,[6] the definition of an asset in the FASB's Concepts Statements,[7] and the relevant FASB Revenue TRG[8] discussions.[9] As a reminder, the guidance for incremental costs of obtaining a contract with a customer in ASC 340-40 excludes consideration payable to a customer.[10]

From my perspective, a company must first determine what the payment was made for. The following are some of the questions that OCA staff may focus on to understand the nature and substance of the payment:

1. What are the underlying economic reasons for the transaction? Why is the payment being made?
2. How did the company communicate and describe the nature of the payment to its investors?
3. What do the relevant contracts governing the payment stipulate? Does the payment secure an exclusive relationship between the parties? Does the payment result in the customer committing to make a minimum level of purchases from the vendor?
4. What is the accounting basis for recognizing an asset, or recognizing an upfront payment immediately through earnings?

Once a company has determined the substance of the payment, I believe a company should account for the payment using an accounting model that is consistent with the identified substance of the payment and relevant accounting literature. Additionally, companies should establish accounting policies that are consistently applied. I'd highlight that there should be a neutral starting point in the accounting evaluation for these types of arrangements. I believe that registrants must carefully evaluate all of the facts and circumstances in arriving at sound judgments, and should perform the analysis impartially. Additionally, in my view "matching" is not a determinative factor to support asset recognition.

As a reminder, OCA is available for formal consultation. I would direct you to the SEC website for more guidance regarding consultation with the Office of the Chief Accountant.[11]

New GAAP: Gross vs. Net Revenue Presentation and Disclosures

Importance of Information to Investors

Moving on to gross vs. net revenue matters. Over the past few years, including 2016 year to date, revenue recognition has been the number one topic of consultation with OCA. Among revenue consultations, over 30% relate to gross versus net revenue presentation matters. The presentation determination and resulting disclosures associated with whether a company is the principal in a transaction and, therefore, should report revenue on a gross basis, or is the agent, and therefore should report revenue on a net basis, is important to investors. This determination informs investors with respect to (1) who the company believes is its customer; (2) which specified good or service the company is selling to the identified customer; and (3) the amount of revenue earned and the profit margins reported by the company on the transaction.

There has been significant focus on the overall presentation conclusion impacting the income statement. Additionally, the disclosures required by the standard should help investors understand both the accounting judgments that went into the gross or net revenue presentation utilized in the primary financial statement[12] and the transaction cash flows in the context of the relevant underlying contracts.[13] Regardless of whether a transaction has been presented on a gross or net basis, I believe these types of disclosures under the new revenue standard are particularly important to investors as they permit investors to clearly understand the company's role in the arrangement.

Moving from a "Risks and Rewards" Framework to a "Control" Framework

As has been noted in TRG discussions and by AICPA[14] industry groups, in some cases the accounting determination of whether a company is the principal or the agent under the new revenue standard could be different from a company's conclusion under current GAAP.[15] Accordingly, companies will need to revisit their current principal versus agent conclusions based on the premise of the new revenue standard (control) and may need to look towards the indicators[16] the standard setters provided. Additionally, I caution a registrant from viewing either gross or net reporting as a default or a safe harbor, since there is no such default or a safe harbor in the new revenue standard. The specific facts and circumstances of an arrangement must drive the final accounting conclusion.

Evolving Business Models

I would like to make one more broad point regarding the gross versus net conversation. As industry lines merge and business models evolve, it is important for everyone involved to understand that the gross versus net revenue presentation questions that the "technology" companies have dealt with for a number of years are questions that others may now need to address. To illustrate the point on evolving business models, consider the financial services company that partners with a technology company to make advances into the FinTech space. Oftentimes, the nature of the promise to the customer and method of delivery of that promise to the customer, especially in service transactions, create unique challenges that will require sound judgment and adherence to the principles of the new revenue standard. Historically, certain companies may not have thought about some of the questions that will need to be considered; however, given the continued evolution in business offerings and models, and the new revenue standard, this an issue that is relevant and should be a focus point for management.

Selection of Assumption Underlying Pension Interest Cost

Moving on to a point regarding pension accounting, last year at this conference,[17] a member of the OCA staff made remarks about approaches to developing a key assumption — the discount rate — used to compute the interest cost component of a sponsor's net benefit cost for a single-employer defined benefit pension plan. The staff member noted that OCA staff consulted with companies and accounting firms on two approaches to developing the key discount rate assumption — a single weighted-average approach and a disaggregated approach, referred to as the "spot rate" approach. OCA staff did not object to the use of the single-weighted average or the spot rate approaches to estimating appropriate discount rates, since in those consultations the registrants would use the same yield curve data embedded in the measurement of the PBO as used in estimating interest cost.

This year, OCA staff consulted on a different fact pattern regarding the use of the spot rate approach to estimating an appropriate discount rate when yield curve data is not used in measuring the PBO, as is the case when using a hypothetical bond matching methodology to measure the PBO. The staff objected to the use of the spot rate approach in this fact pattern, stating that OCA staff's views have not changed since last year's remarks, which noted that the "measure of the pension obligation and the determination of interest cost are integrated concepts."[18] In the fact pattern discussed last year, OCA staff noted that "the source data about market interest rates used in estimating a discount rate was… taken from the measurement of the pension benefit obligation."[19] In contrast, a discount rate is not used in the fact pattern from this year's consultation regarding a hypothetical bond portfolio method, since that method is premised on the cost of a selection of bonds.

What this means is that you should start with your balance sheet first — measure the PBO — and then, as required by GAAP,[20] attribute the change in the PBO to the various components, including interest expense, of net pension cost. In computing your pension interest expense, one should use the same information that was utilized for balance sheet measurement or the single-weighted average approach, which is explicitly allowed by GAAP.[21]

Implementation of the New Leases Guidance

Finally, I would like to mention OCA's efforts during the transition period related to the new leases guidance.[22] Since the issuance of the new guidance, which registrants are permitted to begin applying immediately and must do so by 2019, OCA has consulted with registrants on implementation questions and has been actively monitoring the collective efforts of stakeholders to understand how implementation issues will be addressed. I would encourage preparers, accounting firms, and others to continue to work together to achieve consistent application of the new standard with a view towards promoting comparability.

Application of the new leases standard requires companies to make judgments in financial reporting that will later be evaluated by auditors, regulators, and investors. The importance of ICFR[23] cannot be overstated and will be a key factor for preparers in arriving at well-reasoned judgments that are grounded in the principles of the new leases standard.

Closing

Thank you for your kind attention. This concludes my prepared remarks.