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Determine the Transaction Price

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Recognize Revenue

Have you constructed (or reconstructed) your revenue recognition process?

RevRec1The FASB’s new revenue recognition accounting standard promises to shake up existing processes, controls, and contracts that have been developed (at least in the U.S.) around very prescriptive rules. It transforms the guidance into a flexible, principle-based model that’s foundation is substance over form—and, ultimately, attempts to install a bay window providing a wider view into revenue for investors and stakeholders. The building blocks are comprised of a five-step prototype that requires heavy lifting by CFOs, controllers, and most other departments that have contracts, data, systems, or processes, that impact or are impacted by revenue recognition. While the FASB has delayed the groundbreaking dates of the revenue recognition standard to reporting periods on or after December 15, 2018, for nonpublic companies (and December 15, 2017 for public companies), it requires collecting up to three years of annual and/or quarterly comparative data should an organization choose the retrospective application option. So you should start the construction or retro-fitting of your processes as soon as possible.

Revenue Recognition Timing

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Departments Impacted by Revenue Recognition

The changes are deep and wide

New Revenue Recognition Rules Survey

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The new rule supersedes all existing industry-specific guidance. Accordingly, companies whose contracts and business processes have been developed around industry-specific revenue recognition rules may need to consider appropriate changes to their methods of negotiating contract terms with customers. Software, telecommunications, and construction companies—among others—currently follow industry-specific accounting guidance that drives revenue recognition. Under the new rules, the timing and amount of revenue recognized may change.

Rev Rec Multiple DeliverablesIn multiple-element contracts—such as those for software, installation, and maintenance services—the new rules may result in changes to revenue recognition due to the bundling or unbundling of contractual elements or “performance obligations.” Each contract will have to be evaluated under the 5-step approach, which could result in significant changes to timing of recognition, price allocation, and/or necessary disclosures.

The new revenue recognition standard will require companies that license intellectual property (IP) to determine whether they are selling (a) access to the IP, or (b) the right to use the IP. Provision of access occurs over time, whereas provision of the right to use IP occurs at a point in time. Under the new rules, revenue from the provision of access to IP will be recognized over time, and revenue from the provision of the right to use IP will be recognized as soon as that right is transferred to the customer. Distinguishing these two performance obligations can be further complicated by any existing nonstandard agreements with respect to IP licenses.

Rev Rec Debt Covenants 2If yes, then review the terms to determine whether modifications are necessary due to the changes in the timing of revenue recognition. Without appropriate amendments to such covenants, some companies may—through no fault of their own—violate the covenants if their financial metrics change upon implementation of the new accounting standard.

Rev Rec Financing Components 2Significant financing components can benefit the company or the customer due to the time value of money, and those benefits must be reflected in the transaction price used to recognize revenue under the new standard. This change may present challenges for affected companies whose systems and processes do not currently encompass measurement and tracking of the time value of money. Additionally, the determination of whether or not a financing component exists—not to mention whether or not such financing components are “significant”—can require a great deal of judgment.

Rev Rec Variable Consideration 2There are many circumstances that can produce variable consideration. Examples include contingencies for events occurring or not occurring (e.g., customer returns), discounts or credits based on sales volume, royalties, and incentives/performance bonuses. You may be accustomed to delaying recognition of variable consideration until it’s received or earned. The new rules, however, require management to estimate variable consideration upfront so that it can be included in the transaction price used to record revenue. This step may result in changes to revenue recognition and the related disclosures—as well as the need for new processes and controls to create accurate estimates and monitor them.

Rev Rec IRS deferralBecause of the anticipated acceleration or deceleration of revenue recognition for many companies, the new rules may decrease deferred revenue for financial statement purposes, which will—in turn—decrease the amount of advance payments that can be deferred for tax purposes. If your company typically takes advantage of this tax deferral opportunity and routinely receives advance payments for goods and services, gift cards, and subscriptions, then you will want to assess the new standard’s impact on the timing and amount of your cash tax payments.

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