Revenue Recognition Standards for Your Company are Headed Your Way – Get Ready Now
Deliberations over new revenue recognition methods began as far back as 2002, with re-deliberations continuing until the Financial Accounting Standards Board (“FASB”) issued their final standard in May 2014. The FASB’s new Accounting Standard Update (“ASU”) 2014-09, Revenue from Contracts with Customers, is effective for private companies’ financial statements issued for periods after 12/15/17 (i.e., 2018 calendar year statements), with retrospective application.
Nonpublic entities may elect to early apply the requirements of the revenue standard for annual periods beginning after December 15, 2016. The implementation date may seem far off, but companies should begin planning for the new standard now to determine how it will affect the entity’s revenue recognition policies and the potential financial impact on the organization, and to ensure that management is prepared to adopt the standard.
The new rules will provide a single model designed to promote consistency that will apply to virtually all entities (public, private, and not-for-profit, and regardless of industry) that enter into contracts with customers. ASU 2014-09 replaces virtually all U.S. Generally Accepted Accounting Principles (“GAAP”) guidance that currently exists on revenue recognition. Here are some of the major changes to expect:
- No more industry-specific guidance. The new ASU eliminates the transaction- and industry-specific revenue recognition under current GAAP and replaces it with a principle-based approach for determining revenue recognition.
- No more “transfer of risks and rewards.” Under the new standard, revenue is recognized when a company satisfies a performance obligation by transferring a promised good or service to a customer, which is when the customer obtains control of that good or service, not when the transfer of risks and rewards occurs. Indicators of customer control may be evidenced by legal title, an unconditional obligation to pay, physical possession, or a design or function that is specific to the customer’s specifications. A performance obligation may be satisfied at a “point in time” or “over time.” For example, manufacturers of goods made according to customer specifications may be required to recognize revenue as the units are produced, versus upon delivery, as under current GAAP.
- Different performance obligations. Under the new standard, if a company provides services as part of its warranty obligations, the promised service may be considered a separate performance obligation that requires allocating a portion of the transaction price to each obligation.
- No more “reasonable assurance of collectability” recognition thresholds. Under current GAAP, collectability refers to the customer’s credit risk, i.e. whether the reporting entity will be able to collect from the customer. Under the new standard this is eliminated. Instead, the transaction price will be equal to the amount of consideration the company is entitled to, not the amount the company expects to receive. Impairments of customer receivables will be separately presented as an expense.
- No more “fixed or determinable” requirements. Under current GAAP, consideration must meet these requirements and variable amounts (such as rebates, refunds, credits, and incentives) are not included in revenues until the variability is resolved. Under the new rules, companies are required to estimate the total consideration it is entitled to (using either the “expected value” approach or the “most likely amount” approach) and update that estimate at each reporting date.
- Allocation of transaction price. Under the new rules, all reporting entities will allocate the transaction price to the good or service underlying each performance obligation on a “stand-alone selling price,” the price an entity would sell the good or service separately to the customer. This is similar to current GAAP; however the key distinction under the new rule is that it applies across all industries, including the software industry. The new rule will likely accelerate revenue in many instances because certain entities that must now defer revenue will be able to recognize revenue earlier.
- Long-term contracts rules are changing. Current GAAP requires companies to recognize revenue based on reliable estimates. The new rules dictate that performance obligations are satisfied over time only if certain criteria are met and revenue will be recognized only when control of the asset is transferred to the customer. However, although the thought process and terminology will be different, the percentage of completion method has not been eliminated under the new standard and revenue recognized may be similar to the method currently in use.
- Licensing rules are changing. New rules will likely accelerate revenue recognition associated with licenses accounted for as a promise to provide a right. Other licenses will be accounted for as a promise to provide access to property. There will now be one standard approach for accounting for licenses that will apply to all industries.
While the aforementioned changes are by no means all-inclusive, they do represent some of the most significant changes that can be expected. All companies should begin the process of determining the elements applicable to their organization. Companies will be required to evaluate the new standard and disclose the possible effects on the entity’s revenue recognition in the years prior to the effective date.
The new revenue standard will affect companies in a myriad of ways, including the need for new accounting policies and financial reporting changes and disclosures, new internal controls and processes, new operations and performance metrics, possible contract revisions, investments in employee training, and changes to information systems. Although companies have significant lead time to prepare before implementing the final rules, the time for analysis and planning for the effects of the new rules is now. Please contact your HLBGC advisor and let us know how we may assist you.