When the Financial Accounting Standards Board ("FASB") passed Accounting Standards Update ("ASU") 2014-09 for revenue recognition, concern about the time and requirements involved with implementing the standard arose quickly. Despite several years passing, concern remains about regarding these new requirements. Companies in every industry are looking into how this ASU will affect their financial reporting.
The change in the revenue recognition standard will affect the documentation requirements needed to support the revenue recognized. In preparation for the new standard, which takes effect for non-public entities in fiscal years beginning after December 15, 2018, please consider the documentation related to the key points below. Although this level of documentation will not be needed for the financial reporting of fiscal years beginning before December 15, 2018 (for non-public companies), any contracts that are not considered complete under the old revenue recognition standards during that fiscal year will be subject to ASU 2014-09. It is very important to start aggregating the following information, for both internal control requirements and audit support.
ASU 2014-09 requires the following five steps in recognizing revenue:
Step 1: Identify the contract(s) with a customer.
Step 2: Identify the performance obligations in the contract.
Step 3: Determine the transaction price.
Step 4: Allocate the transaction price to the performance obligations in the contract.
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.
To assist in maintaining compliance with new standard, keep in mind some of the key points below:
- The Entity should maintain a list of all large contracts.
- The new revenue recognition standard will affect the manner in which auditors test revenue. Because identifying the contract with a customer is the first step in the new ASU, the starting point of testing selections will be the contract. In order to expedite the selection process, please have ready a comprehensive list of contracts that relate to the revenue earned during the period. If, in the beginning, it proves too time consuming and costly to create a full and comprehensive list of all contracts, please continue to put the larger contracts on the list. This list will be especially useful during the first year of implementation to identify contracts that were not completed under the old revenue recognition standard.
- The Entity should maintain a policy that outlines the standard performance obligations.
- You will likely find that the larger contracts have similar, if not the same, performance obligations. A performance obligation is defined by the new standard as a promise in a contract with a customer to transfer a distinct good or service to the customer. Each good or service is distinct if it is separately identifiable in the contract, and the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer. A standard, documented, and adhered to policy for determining the obligations will assist the auditors in testing revenue, and could also reduce time and stress for the Entity in identifying performance obligations.
- The Entity's policy for determining the price of the transaction and allocating that price amongst the performance obligations.
- Once steps 1 and 2 have been completed, the total transaction price of the contract will be determined. This price must then be allocated to each of the performance obligations so that revenue will be recognized appropriately upon the completion of each obligation.
The above mentioned documents will not satisfy all audit related requirements. They are to be used as general recommendations in getting the Entity ready for the audit related to the fiscal year beginning after December 15, 2018.
A simple example of a performance obligation that will be modified by new the revenue recognition standard is the contractual maintenance involved with a lease. As described in the second and third bullet points, because the maintenance performed by the Lessor can be considered a distinct obligation from the rest of obligations in the contract, the price of the contract that is generated through the performance of maintenance must have a portion of the contract price allocated to it and the recognition of this price will occur as the required maintenance has been performed. Once again, it is prudent to have a clearly documented policy for how the Entity determines the transaction price and allocates that price to the performance obligations.
As the above example illustrates how the new definition of a performance obligation can result in a change in the allocation of the contract price, the following example stands to illustrate how defining the performance obligations and allocating the relevant portions of the contract price can result in a change in revenue recognition timing. Under current generally accepted accounting principles ("GAAP"), commercial real estate lease brokerage revenue is recognized when contingencies are resolved (e.g. lease execution, tenant occupancy, payment of first month rent). Under the new revenue recognition standard, entities that engage in this form of business will typically satisfy the performance obligation with their customer upon the execution of the lease and the portion of the commission that is contingent on future events will be accelerated if it is not deemed subject to significant reversal.
Please feel free to reach out for to us for help with your Entity's specific requirements. Our firm will stay on top of this and all updates, provide more resources related to this ASU, and follow up with our clients to help them navigate through the impact of the new revenue recognition standard.