IFRS 15 – a big threat to compensation arrangements? Sure, whatever you say…

“Revenue Standard causes concern about compensation arrangements” says the headline of a recent article in the Journal of Accountancy.

Here’s an extract:

  • “Compensation arrangements are emerging as a big concern for companies as they implement the new revenue recognition standard.
  • Many companies have compensation plans for sales personnel, executives, or others that are tied to revenue metrics or trends. Companies that are working to implement the standard are encountering challenges with those kinds of compensation policies, Eric Knachel, CPA, a partner in the Professional Practice Group with Deloitte & Touche LLP, said in an interview…
  • For some companies, the standard will change the timing of when revenue will be recognized and therefore may change the way compensation is awarded under existing arrangements. “This has a direct dollar impact for the companies in terms of how much they are going to pay out,” Knachel said. “And, maybe more importantly, it has a direct impact on individuals, how much money the individuals at the company are going to get under these plans.”
  • Existing compensation arrangements did not contemplate the new standard, he said. And the effects of the standard on compensation arrangements differ, depending on the industry and how the individual company structures its plan. The new standard could result in earlier recognition of revenue, which could lead to higher commissions or bonuses—one reason companies may need to include human resources in their discussions as they implement the standard…”

This may all seem rather amusingly familiar, because the impact on compensation was frequently included in the “laundry list” of considerations for entities during Canada’s transition to IFRS (I can say this with dismal certainty because I was often delivering those speeches, or writing that material). Practitioners find it an appealing point to highlight, I imagine, because it resonates with an issue that carries direct interest for senior management, perhaps providing a route to more elevated (and lucrative) conversations and engagements. As far as one can determine though, companies usually steer through it without much difficulty (for instance, this CPA Canada report on the Canadian changeover experience, based on interviews with preparers and auditors, didn’t have anything to say about compensation-related challenges).

When I say this is amusing, I mean it in this black sense: how could anyone expect us to believe, at this advanced stage in the evolution of modern business, that the momentum of executive compensation will ever be damaged by financial reporting? Enhanced disclosure was intended to provide a control on such arrangements (“sunlight is the best disinfectant”); now it’s generally believed only to have added fuel to the upward spiral (weeds love sunlight, who knew?). People love to chatter about “pay for performance,” but in practice, performance always gets measured so that pay goes up. At this point, everything to do with executive compensation is perhaps best regarded as a grandiose form of theatre, disconnected from any credible science or psychology. To suggest the show might be seriously hampered by accounting changes is roughly like thinking they might cancel a grand opera because the lobby bar runs out of peanuts.

Still, the interviewee Knachel gives it a more than solid shot:

  • “The first step in implementation is forming a team with representation from a broad range of functions, both at the corporate level and the business unit level, Knachel said. The finance and accounting function will take a leadership role. Other groups on the team could include:
  • Human resources. The first issue for HR is making sure the organization possesses enough people and the appropriate training to handle implementation of the standard. HR also can address the standard’s effects on compensation.
  • Information technology. Some companies are finding that their existing systems—with some add-ons—can handle the accounting changes. Others may need new systems. At any rate, accounting will need to cooperate with IT to accomplish the gathering and reporting of data, including disclosures, required by the new standard.
  • Legal. A review of contractual obligations in the context of the standard almost certainly will be necessary. Contractual arrangements, particularly concerning items such as termination provisions, pricing, and enforceable obligations, may need to be reconsidered as a result of the accounting rules.
  • Sales personnel and those charged with establishing processes and internal controls also could play important roles on the implementation team. Once the team is in place, implementation may start with a technical assessment of the standard, said Knachel, who advises breaking it down into manageable components.
  • First, companies can take an inventory of their revenue streams, choosing sample contracts from each of them. Applying the guidance in the standard to those sample contracts, they can identify the accounting requirements, tension points, and open questions. “Once you’ve analyzed a particular revenue stream, not only can you evaluate and work through any technical issues, but then you can evaluate the impact on other aspects of the business,” Knachel said…

And it keeps on going from there. No doubt some companies exist for which this will be an important and timely wake-up call, saving valued senior individuals from unforeseen loss and inconvenience. Some of those companies may even be incorporated on this very planet…

The opinions expressed are solely those of the author

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