Addressing Implementation Matters to Improve Financial Reporting

Sagar Teotia, Deputy Chief Accountant

San Diego, CA

Sept. 21, 2017

The Securities and Exchange Commission ("SEC" or "Commission") disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.

Introduction

Good afternoon and thank you for the kind introduction.

Before I begin, let me remind you that the views expressed are my own and not necessarily those of the Commission, the Commissioners, or other members of the staff. Let me first express a word of gratitude to the accounting group ("Accounting Group") within the Office of the Chief Accountant ("OCA") for their work on the new GAAP standards that we will be discussing today. I also want to specifically acknowledge Michael Berrigan, Sylvia Alicea, Ruth Uejio, and Rahim Ismail for their assistance in today's remarks. The focus of my remarks today will be on the implementation of the new GAAP standards, specifically revenue recognition,[1] leases,[2] and measurement of credit losses on financial instruments[3] ("new GAAP standards"). I will speak to the important role that preparers, auditors, and audit committees have in achieving the implementation of these standards.

Update on OCA

Before going further, I would like to also acknowledge one recent change in OCA. I would like to welcome Jonathan Wiggins as the new Senior Associate Chief Accountant in the Accounting Group. Jonathan will be joining Kevin Vaughn as our two Senior Associate Chief Accountants in the Accounting Group.

New GAAP Standards

The observations I will discuss today are derived from the experience we have had with the implementation of the new GAAP standards. In addition to speaking both generally about the new GAAP standards and then specifically about revenue recognition, I will also provide an update of our observations on leases and credit losses. I am mindful of the fact that the effective dates for leases and credit losses are further away than revenue, but I did want to share with you some of our observations.

The changes required by these new standards represent enhancements from current GAAP. For example, the new revenue recognition standard provides a single comprehensive model for companies to account for revenue arising from contracts with customers, provides for improved disclosures, and in most areas aligns with IFRS. The new leases standard will improve financial reporting by generally requiring companies to recognize assets and liabilities created by leases on their balance sheets and by enhancing disclosures. Finally, the new credit losses standard will generally result in earlier recognition of credit losses by requiring an estimate of current expected credit losses that considers certain forward looking information.

Before I delve into each of these standards, I want to thank all involved in the financial reporting process for stepping up to the challenge regarding the implementation of the new GAAP standards. While there is significantly more work to be done, a meaningful amount of progress has been made towards implementation and the efforts to date have been a true collaborative effort by preparers, auditors, audit committees, standard setters, and regulators, and has been done both domestically and internationally.

Here are six broad observations that I would like to share regarding the new GAAP standards:

Observation 1: Keep Going / Get Going

There has been a significant amount of progress made by many companies and I want to applaud and thank the work invested by these companies in their implementation. To these companies, I encourage each of you to keep the momentum and "finish strong" with revenue implementation. The work and progress you have made is a great example of companies who will be providing investors with enhanced financial reporting.

For those companies that may be in the earlier stages of your implementation efforts, I would encourage you to significantly ramp up your efforts. There is still time for developing an approach to achieve successful implementation but the time to get going is clearly now.

Given the effective dates, I expect companies' implementation activities related to the revenue standard to be much further along relative to implementation activities related to the other new GAAP standards.

I will also speak later to the benefits of starting now, including the importance of having adequate time to make reasonable judgments, having sufficient time to identify accounting questions, and having adequate time to implement relevant internal controls. All of these items are critical and to the extent you haven't started, "starting now" will allow you enough time in order to implement all that is required related to these new GAAP standards.

Also, I would encourage companies to not just think about the implementation efforts of the new GAAP standards sequentially based on the effective date of each standard. While this may be an option and for some companies may be selected as their ultimate method, I would encourage companies to consider implementing these standards concurrently or partially concurrently. Implementation will likely be easier and more efficient if done (fully or partially) concurrently, especially where system enhancements may be involved.

Observation 2: Internal Control over Financial Reporting

The new GAAP standards will most likely impact internal control over financial reporting ("ICFR"). For instance, there are many areas of the new revenue standard where it may be most effective and efficient to think about the accounting, disclosures, and ICFR concurrently, including the disclosure of disaggregated revenue and the disclosure of remaining performance obligations. For example, while a registrant is determining the accounting impact – that is, identifying its performance obligations and estimating and allocating the transaction price – a registrant should also consider how it plans to disaggregate revenue in order to depict how the nature, amount, timing and uncertainty of revenue and cash flows are affected by economic factors.[4] As a result of this important judgment, a registrant may determine that the data will have to be disaggregated in a manner different than has previously been disclosed. This could require system changes or obtaining data from different personnel – all of which could be subject to new or different internal controls. It takes time of course to implement internal control changes. This is one of the many reasons it is critical to stay on top of raising and resolving implementation and application issues.

Observation 3: Transition Disclosures

On a number of occasions, the SEC staff has emphasized the importance of providing transition disclosures that are articulated in Staff Accounting Bulletin ("SAB") No. 74.[5] As the effective date nears for these new GAAP standards I would expect these disclosures to become more informative to the users of the financial statements.

These disclosures should reflect the state of companies' implementation efforts. As SAB 74 intended, we expect companies to be transparent in their disclosure as to where the company is in its implementation progress. The SAB 74 disclosures are intended to inform a reader where the company is in its implementation progress. As the effective date nears, and for companies that have not made sufficient progress, this fact will become clear in the SAB 74 disclosures. This will allow relevant stakeholders such as audit committee members, auditors and investors to hold management accountable for determining how the company is going to implement the new standards timely.

Specifically related to revenue, I appreciate those companies that have already provided detailed SAB 74 disclosures and have clearly made significant progress in their revenue implementation efforts. However, for others who have potentially fallen behind on their implementation plans, I would urge their audit committees and management to take note of this and focus on creating an implementation plan in order to provide sufficient time and resources to implement the new GAAP standards.

Observation 4: Disclosures within the New GAAP Standards

As I will discuss later in more detail, each of the new GAAP standards require disclosures that I believe will provide investors with useful information. For example, many companies have spent a significant amount of time preparing to apply the recognition and measurement aspects of the new revenue standard. However, as we are now moving closer to the effective date, if you have not started work on the required revenue disclosures – such as the disclosure of remaining performance obligations and disaggregation of revenue – you are at risk of falling behind. These are important disclosures, and I have observed that preparation of those disclosures can potentially be time consuming; thus, providing yourself with sufficient time and resources to complete the disclosures is critical.

Observation 5: Importance of Reasonable Judgment

OCA staff will continue to accept reasonable judgments in the application of the new GAAP standards. As evidence of this, we have already answered numerous pre-filing consultation questions regarding the new GAAP standards where we have accepted reasonable judgments. This point underscores the importance for companies to put in place a good implementation process that enables them to apply sound judgment. We note that well-reasoned judgments frequently require the important element of time in order to gather the facts, consider the accounting alternatives, and make a judgment on the conclusion. To come back to what I said earlier, this is yet another example of why having enough time to implement these standards is so crucial.

Observation 6: Role of Audit Committees in the Implementation of the New GAAP Standards

The process of implementing the new GAAP standards is a collaborative effort from different stakeholders, and the importance of the audit committee in promoting an environment for management's successful implementation of the new GAAP standards cannot be overstated. Through its oversight function, audit committees play a key role in establishing the right "tone at the top" for a company. The tone at the top establishes the environment and culture within which financial reporting occurs, and is a key factor contributing to the integrity of the financial reporting process. Audit committees should continue to set the tone for the adoption of the new GAAP standards. This should include actively monitoring the implementation efforts, including taking the time to understand, and assess the quality and status of implementation. Simply put, I believe the tone set by an audit committee can affect the quality of a company's implementation, including judgments made by management, and, ultimately, the quality of information provided to investors.

Let's now specifically discuss the ongoing implementation efforts for each of the new GAAP standards.

A. Revenue Recognition

First, let's discuss revenue recognition. During the implementation phase, registrants have consulted with OCA on a number of specific fact patterns across a variety of industries. The consultation questions we have received to date relate to a number of topics – several of which have been communicated in previous speeches.[6]

We have observed that some companies have chosen to early adopt and are getting the information to investors now. We applaud their efforts and are encouraged by their progress and commitment to providing transparency to their investors and other users of their financial statements. These companies provide evidence that adoption of the new revenue standard is clearly achievable.

For those whose implementation efforts haven't started or are still underway, the time until required application of the new standard is just a few months away. As noted earlier, we will accept well-reasoned judgments but as a cautionary note generally well-reasoned judgments frequently require the important element of time to make. As companies finalize their company-specific accounting policies and prepare disclosures, OCA staff continues to be available for consultation on a formal or informal basis, as needed, to both domestic and foreign registrants. However, to avoid a massive backlog at the end of the year – which would potentially be a detriment to all stakeholders– the time for those questions is now.

Importance of disclosures

As I alluded to earlier, the new revenue standard requires several new disclosures that are intended to provide investors with information about the nature, amount, timing and uncertainty of revenue and cash flows from customers.[7] Enhanced disclosures were a key objective of both the Financial Accounting Standards Board ("FASB") and the International Accounting Standards Board ("IASB") in their joint project on revenue recognition. This improved transparency of information is a "win" for investors.

However, similar to the judgment that is required to work through the accounting impact, judgment is also sometimes required to provide the new disclosures in a manner that meets the disclosure objective in the new revenue standard.[8] Judgments related to disclosures require time to 1) make judgments about how the information should be disclosed and 2) if need be, to implement system and other internal control changes to gather and present the data.

Also we have stressed the importance of SAB 74 disclosures. The assessment of the materiality of the new revenue standard must include consideration of the new required disclosures. In addition, as we approach the fourth quarter of 2017, it is critical for the transition disclosures to be as informative as possible to the users of the financial statements.

B. Leases

Turning to the FASB's new standard on leases, which will be effective beginning in 2019 and can be early adopted, this new standard will also require careful implementation planning, management, and oversight.

Why it matters

Under the new guidance lessees will now recognize an asset and liability for nearly all of their leases. I believe that this is a "win" for investors and other financial statement users as the new guidance results in improved transparency and consistency in accounting for lease arrangements.

In addition to bringing most leases on balance sheet, the new leases standard calls for enhanced disclosures of lease arrangements.[9] As stated in the new leases standard, "the objective of the disclosure requirements is to enable users of financial statements to assess the amount, timing, and uncertainty of cash flows arising from leases."[10] These disclosures are valuable in increasing transparency of lease arrangements to the users of the financial statements and I commend the FASB on enhancing the disclosures within this area for investors.

Status of implementation of leases

As with revenue recognition, I encourage companies to assess the quality and status of implementation plans to achieve the financial reporting objectives.

As I mentioned earlier, to the extent a company has not yet commenced with its implementation efforts for leases, I encourage companies to consider beginning its leases implementation efforts now. While this is not necessarily required, sequential implementation of the revenue recognition standard followed by the leases standard may leave a company in a situation where it finds that it has potentially limited its time to adopt the new leases standard and has limited its time to formulate reasonable judgments and assess potential changes needed in ICFR.

The lease standard will require several steps including (but not limited to) the following: Identifying relevant legal contracts, evaluating whether an arrangement is or contains a lease, and applying the new leases standard to arrangements within its scope. These steps can potentially be time consuming and are another reminder of why getting started as soon as possible is a best practice.

Given the significant amount of work done on revenue, there are many lessons learned[11] that can be leveraged to more successfully implement the leases standard.

A couple of the lessons learned that are relevant to leases include:

• Companies should have appropriate resources to evaluate lease arrangements and properly apply the principles of the new standard. While those resource needs may be satisfied, for example, through a designated accounting policy function or through a relationship with a qualified service provider, having resources with sufficient training and competence is fundamental to the effectiveness of a company's overall control environment.

• The new leases standard will require judgments. This highlights the importance of another element of a company's control environment – setting the right "tone at the top" and expectations for responsible conduct throughout the organization. Appropriate tone at the top is the foundation for the consistent application of the sound judgments required by the new standard.

Unlike the new revenue recognition standard and credit impairment standard, the FASB did not establish a Transition Resource Group ("TRG") to support the implementation process of the new leases standard as it was observed that the "scope of educational changes is not as significant"[12] as the revenue recognition or credit losses standards. While a TRG was not established for the new leases standard, I believe that it is very important for companies to be actively involved in raising accounting questions related to the new leases standard. Said differently, in order to maximize its part in being in the profession's current dialogue regarding the identification and resolution of accounting questions related to the new leases standard, a company should continue to identify accounting questions and raise those questions as soon as possible.

To the extent questions are arising as a result of the implementation process and resolution requires dialogue with the OCA staff, the staff of the OCA is ready and available and we welcome your questions.

Finally, I would like to mention OCA's efforts during the transition period related to the new leases guidance. We continue to focus on the key elements of our transition strategy. We are actively monitoring the profession's implementation efforts and since the issuance of the new guidance, OCA has met with various constituents including preparers, industry groups, standard setters, and accounting firms to identify the nature and volume of implementation questions and views on those implementation questions that have been emerging. To date, the majority of the accounting questions that have been raised to our attention relate to scoping and transition matters. OCA has provided views on certain lease questions (primarily in the scoping and transition space) and consistent with our work done on revenue recognition, we have and will continue to accept reasonable judgments in the leasing space as well.

C. Credit Losses

I'd like to turn now to the FASB's new standard on credit losses ("CECL"). The issuance of this standard represents the continued development for the accounting of credit losses which reflects the importance of timely and reliable financial reporting, particularly to investors.

Why it matters

This standard clearly has a significant impact on banks and other financial institutions, but the impact goes beyond any particular industry group.

We have heard many analysts and financial statement users support the credit loss standard as an improvement over the current incurred loss model. These stakeholders are supportive of the FASB's improvement to the accounting standards related to the recognition of credit losses with a new standard that allows for judgment in loss estimates.

In finalizing this standard, the FASB conducted tremendous due process through broad outreach with all stakeholders, including users, preparers, and auditors of financial statements to obtain information about potential deficiencies in previous GAAP and financial statement user needs under the new standard. The FASB's outreach activities included 25 fieldwork meetings; over 10 public roundtables (attended by more than 100 representatives including preparers, regulators, auditors, and financial statement users); more than 85 meetings and workshops with preparers; and the FASB also met with more than 200 users of financial statements prior to finalizing the standard.[13]

Status of implementation of CECL

The new credit losses standard represents a change in how entities account for credit losses. Implementation of the new standard is of course important and successful implementation requires companies to allocate sufficient resources and develop or engage appropriate financial reporting competencies in this area.

Wes Bricker recently spoke[14] on CECL so I will keep my comments brief in this area and focus only on areas OCA has worked on related to CECL.

OCA has spent considerable time evaluating the requirements of the new standard and monitoring implementation activities. We are actively monitoring the profession's implementation efforts underway including observing the discussions at the TRG to identity the nature and volume of implementation questions and views that are emerging with respect to implementation.

Additionally, we have been meeting with various members of the accounting profession including representatives from registrants, accounting firms, various regulators, and industry groups to obtain an understanding of the various implementation questions arising and how to address implementation issues. By actively monitoring implementation efforts, we will be able to identify areas where differences in views may be occurring and where further work may need to be performed.

I'd like to share a few observations we've learned from our monitoring activities:

• The importance of coordination among all stakeholders in the transition and implementation activities. This includes preparers and auditors moving in parallel with one another so as to avoid one group from being significantly ahead of the other.
• Registrants are making progress on implementation and continue to elevate interpretative concerns to OCA.
• The TRG remains a forum for stakeholders to potentially work through and address implementation issues. As preparers, industry groups, and other stakeholders continue their implementation efforts, I would encourage them to consider referring challenging issues to the TRG. OCA of course will continue to participate as observers in the TRG meetings.
• Consistent with revenue recognition and leases, OCA will accept well-reasoned judgments in the application of this new standard.

Closing

In closing I want to thank preparers, auditors, audit committees and other stakeholders for all the effort to date in the implementation of the new GAAP standards. The new GAAP standards will provide investors with enhanced financial reporting and disclosure. I know the profession, as it has many times before, will be successful in meeting the challenge of implementing the new GAAP standards and we in OCA will continue to be available to help. I want to thank you again for the opportunity to be with you today.