When you talk about Revenue Recognition with your colleagues, you often talk about what you need to do to be in compliance with ASC 606. But, how often do you talk about the consequences if you're not?
The consequences can be different depending on ownership of the company. Public companies tend have a lot more scrutiny but private companies have a lot of skin in the game as well.
Let’s take a look at a few reasons why ASC 606 is needed, regardless of ownership.
- Creating transparency in financial reporting to reduce and prevent fraud
- Standardizing methods and assumptions across companies, industries, and regions for easy cross-company comparisons
- Accurately depict the health of a company for investors and stakeholders to make evidence-based decisions
- Guardrails around consistency to ensure quarter over quarter analysis for both internal and external parties
So what happens if I find my business in a state of noncompliance? Noncompliance around financial reporting can result in deficiencies to the point of Material Weaknesses, often identified by a company’s auditor. We find that if a Material Weakness is identified, the following can and does happen:
- A loss of confidence from investors (again, both public and private)
- Increase in external audit fees (to identify and to address the Material Weaknesses)
- Increased legal fees
- High risk reputation leads to issues getting loans and/or getting them at a competitive market rate
- Job loss due to a lack of oversight and governance
It’s important to note that deficiencies (up to the level of a material weakness) are identified not because a restatement has occurred but because there is a deficiency in the financial reporting controls such that it could cause a restatement. In the case of a material weakness; a material restatement (but of course!).
Common reasons for Material Weaknesses often revolve around technology. Whether it be the software itself that doesn’t have the proper controls, security issues within the technology or within the business process, and segregation of duties within the software. When implementing critical financial systems, be sure you are addressing the following:
- The technology holds a SOC I, Type II compliance report
- Controls are either native to the system or thoughtfully installed through business process
- Access to the system is restricted to users who NEED access and this is easy to shut off in case of a departure
Not all companies with deficiencies end up with a 16% drop in stock price like Revlon did in 2018, or with massive legal fees and class action lawsuits like Marriott in 2019 (rough timing on that one), but it’s still important for both public and private companies to maintain the proper controls and compliance with their people, process, and technology.