The SEC has made clear its expectations regarding MD&A disclosure for periods prior to the adoption of the new revenue recognition standard. What has received less attention is the content of MD&A after the new revenue recognition standard has been adopted. Set forth below are some guidelines to be considered. While putting pen to paper to draft the first MD&A is still months away, public companies need to begin crafting disclosures controls and procedures so they will be in place when disclosures must be made.
The first step in drafting an MD&A will be to understand the company’s elected transition method to the new standard. The Financial Reporting Manual of the SEC’s Division of Corporation Finance described the transition choices as follows:
- Retrospectively to each prior period presented, subject to the election of certain practical expedients (“full retrospective method”). A calendar year-end company that adopts the new revenue standard using this method must begin recording revenue using the new standard on January 1, 2018. In its 2018 annual report, the company would revise its 2016 and 2017 financial statements and record the cumulative effect of the change recognized in opening retained earnings as of January 1, 2016.
- Retrospectively with the cumulative effect of initially applying the new revenue standard recognized at the date of adoption (“modified retrospective method”). A calendar year-end company that adopts the new revenue standard using this method must begin recording revenue using the new standard on January 1, 2018. At that time, the company must record the cumulative effect of the change recognized in opening retained earnings and financial statements for 2016 and 2017 would remain unchanged.
According to this Compliance Week article (subscription required), the new standard is rife with areas that can be critical estimates, including the identification of performance obligations, estimating certain stand-alone selling prices, and estimating variable consideration. We discussed the complexities to be considered under the new standard here when drafting new contracts, including key distinctions regarding the satisfaction of performance obligations over time or at a point in time.
The new revenue recognition standard requires robust footnote disclosures regarding significant judgments in the revenue recognition process that should be invaluable when drafting this part of the MD&A. The footnotes must disclose the judgments, and changes in the judgments, made in applying GAAP that significantly affect the determination of the amount and timing of revenue from contracts with customers. In particular, an entity must explain the judgments, and changes in the judgments, used in determining both of the following:
- The timing of satisfaction of performance obligations.
- The transaction price and the amounts allocated to performance obligations.
The new standard goes on to detail specific disclosure requirements for contracts where performance obligations are satisfied over time, or at a point in time, and outlines specific disclosures regarding matters related to the transaction price.
Appropriate MD&A disclosure will necessarily vary from company to company. The new standard includes almost five pages of required disclosures to be included in the footnotes to the financial statements. The overall goal of the footnote disclosures is to provide sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Reviewing and understanding these disclosures as a whole will be a key step in crafting the initial and on-going MD&As.