The Public Company Accounting Oversight Board (the “PCAOB”) recently released Staff Audit Practice Alert No. 15 (the “Practice Alert”), titled “Matters Related to Auditing Revenue From Contracts With Customers.” The Practice Alert provides guidance for auditors related to the Financial Accounting Standards Board’s 2014 Accounting Standard Update titled “Revenue from Contracts with Customers” (Topic 606) (the “Revenue Recognition Standard”), which goes into effect for annual reporting periods beginning after December 15, 2017. The Practice Alert is available here, and the Revenue Recognition Standard is available here. While the Practice Alert is directed at auditors, it sheds light on what companies can expect from their independent auditors as companies prepare for and implement the new Revenue Recognition Standard. Given the importance of revenue as one of the most important measures that investors use to assess a company’s financial performance, we expect that there will be a keen focus on implementation of this standard by independent auditors.
- Expect Auditors to Seek a Better Understanding of Contractual Arrangements. A key theme of the Practice Alert is that an independent auditor will need a deep understanding of the contractual arrangements entered into by a company to help ensure that the Revenue Recognition Standard is being implemented properly. The Practice Alert contains a number of steps for auditors to use in gaining this in-depth understanding of contractual arrangements, including obtaining information about how management develops revenue-related estimates. The Practice Alert also focuses on specific procedures the auditor should consider in interim reviews to help accelerate an understanding of the contractual arrangements. It is foreseeable that the level of understanding outlined in the Practice Alert could mean the auditor will need additional time with management and with company systems. Companies can prepare for this more extensive interaction by making sure that documentation regarding contractual arrangements and the intersections with the new standard are in order and that relevant personnel are prepared for inquiries from the auditor about the company’s key products and services and key provisions of contractual arrangements.
- Expect Auditors to Closely Review New Controls and Changes to Controls to Implement the New Standard. The Practice Alert also highlights a number of areas for auditors to focus in reviewing internal controls over financial reporting, which will be particularly important during the transition to the Revenue Recognition Standard. Among other things, the Practice Alert highlights that auditors should review controls that companies have in place over the transition adjustments that a company makes to adopt the new standard, whether under the full or modified retrospective approach. The Practice Alert also guides auditors to focus on how management has evaluated the competence of personnel across the organization in taking steps toward adopting the new standard, and whether any outsourced providers have been engaged to address any shortcomings. The Practice Alert also directs auditors to consider risks that may be posed by short-term manual processes that companies may have in place as stopgaps until automated processes and controls can be fully implemented. Companies should be prepared for increased scrutiny of these short-term manual processes and should attempt to create robust controls around the new accounting processes in a timely manner to avoid excessive reliance on manual processes.
- Expect Auditors to Closely Scrutinize Ongoing Revenue Disclosures. The Practice Alert also shines a light on auditor review of narrative disclosures accompanying financial statements. The Revenue Recognition Standard imposes new disclosure requirements related to contractual arrangements, and the Practice Alert underscores that review of such disclosures merits attention from auditors. Companies should seek input from the auditor on drafts of disclosures that address the new standard at an early stage in the process of preparing periodic reports.
The Practice Alert is an important reminder that companies will need to be prepared for what likely will be more extensive interaction with auditors during the transition to implementing the new standard, particularly in the first few interim reviews and initial audit after adoption of the new standard. Given this additional scrutiny expected from auditors, we also expect that audit committees will be keenly focused on progress in implementing the new standard, how internal controls will change and how management will address transition disclosures and potential adjustments related to the new standard.
 The Practice Alert notes that auditors should review transition disclosures and controls for transition adjustments not only for the new revenue recognition standard, but also for other newly-adopted accounting standards, including the lease standard.