Midstream management should start getting ready now for new accounting guidelines that will take effect in 2018 and 2019 financial reports.
By Kurt King
With the challenges the energy industry and midstream sector have endured over the past two years, no one wants to have to respond to more change—particularly due to non-energy specific accounting guidelines. But this is fair warning to begin preparing now: Current U.S. Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) revenue recognition guidelines will converge across all industries and capital markets starting in 2018.
The new U.S. guideline, Accounting Standards Codification Topic 606, goes into effect in 2018 and replaces all current industry-specific revenue guidance. As with all cross-industry solutions, there is a high risk of unintended consequences similar to Dodd-Frank and Sarbanes-Oxley compliance.
Gauging the impact
Each sector of the energy industry will be impacted differently with some contracts for goods and services considered in-scope and others out-of-scope. A key factor in determining whether a contract will be significantly impacted by Topic 606 in the midstream sector is the inclusion of a variable consideration component. For example, this could include an index such as West Texas Intermediate (WTI), Nymex gas price, or the Consumer Price Index (CPI). Or, it could include non-cash consideration, such as percent-of proceeds (POP) and take-in-kind (TIK) processing agreements.
Since most midstream contracts have an index-based component to them, even if it’s merely an annual CPI escalator on a transaction fee-based deal, it is likely most midstream contracts will be in-scope and will need to be evaluated for Topic 606 impacts.
Topic 606 may not change how much revenue an entity receives for the performance of a contract or the timing during which that revenue is recorded; however, the guidelines create a significant amount of compliance processes and reporting requirements that most likely do not exist in organizations today. Topic 606 will have significant impacts to a diverse set of corporate functions such as contract administration, accounting, financial reporting, information technology and planning. Entities should begin identifying the impacts that Topic 606 will have on their organizations, processes and systems today, in preparation for the reporting of 2016 and 2017 retrospective activity upon implementation, effective January 1, 2018.
Revenue recognition background
The FASB and the IASB initiated a joint effort to improve revenue reporting guidance to provide a framework for addressing issues, to improve comparability between industries and capital markets and to provide useful information for financial statements and disclosures. The guidance supersedes the previous Topic 605 requirements and previous industry-specific guidance.
Currently, GAAP revenue recognition standards vary by industry and may result in different accounting treatments for similar transactions across industries. The goal of principles-based accounting is to reduce the number of specific rules and, thus, may make the determination and consistency of accounting across industries more difficult.
The energy industry is vast and diverse from producers, processers, marketers, service providers, refi ners, generators and many other roles. On the one hand, a universal guideline may simplify financial reporting for diversified energy companies. On the other hand, goods and services contracts are very different by sector and may create a “square peg for a round hole” feeling for accounting and finance organizations. A standard that applies to everyone may not be appropriate for anyone...click below to read the full article in Midstream Business.