After more than a decade of work, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have issued new joint guidance impacting revenue recognition, and almost every company will be impacted in some way—although some industries will likely feel the changes more than others. FASB’s version, Revenue from Contracts with Customers, standardizes and simplifies the revenue recognition process for customer contracts across different industries and geographic locations while also requiring more comprehensive footnote disclosures for all types of public and private companies. The SEC intends to review and update Staff Accounting Bulletin Topic (SAB) 104, Revenue Recognition, which provides the SEC’s interpretative guidance related to revenue recognition. Public companies will want to monitor the SEC response to ASU 2014-09 to see how SAB 104 is amended to be consistent with the new FASB standard. But there are revenue recognition basics that every company will likely need to evaluate and implement.
Spoiler alert: many companies are expected to record revenues earlier under the new guidance due to requirements to estimate the effects of variable consideration—such as sales incentives, discounts, and warranties. Therefore, as a result of these changes in timing of revenue recognition, company performance may look different even though the same revenue totals will ultimately be reported. Sit back and read on to determine how to prepare your company for these massive changes.
And Action: 5 Steps for Determining Revenue Recognition
The new guidance implements five steps for determining when and how to properly recognize revenue on financial statements.
- Identify the contract with a customer. The guidance applies to each contract a company has with a customer—assuming that the contract meets certain criteria. In some cases, the company should combine and account for contracts individually.
- Identify the company’s contractual performance obligations (or promises). If a contract contains obligations to transfer more than one good or service to a customer, then the company can account for each as a separate performance obligation only if the good or service is distinct (or a series of distinct goods or services that are substantially the same).
A good or service is “distinct” if:
- a) The customer can benefit from the good or service on its own or together with other resources that are readily available to the customer, and
- b) The company’s promise to transfer the good or service is separately identifiable from other contractual promises.
- Determine the transaction price. The company must determine the amount it expects to receive for the promised goods or services. Factors for consideration include any impact from variable payment or significant financing components.
- Allocate the transaction price to the contractual performance obligations. The company will typically allocate the transaction price to each performance obligation based on the relative “standalone selling price” of each distinct good or service promised in the contract. Any discounts or variable payments that relate entirely to one of the performance obligations should be allocated to that obligation.
- Recognize revenue when (or as) performance obligations are satisfied. The company must recognize revenue when it satisfies a performance obligation by transferring the promised good or service to a customer. The recognized amount is the amount allocated to the performance obligation.
When a performance obligation is satisfied over time versus at a single point in time, then the company must also recognize revenue over time by consistently applying a method of measuring progress toward satisfaction of the obligation.
Preparing for the A-list: Enhanced Revenue Related Disclosures
Currently, most companies provide limited information about revenue contracts. The existing rules require only descriptions of a company’s revenue related accounting policies and their effects on revenue—including rights of return, the company’s role as a principal or agent, and customer payments and incentives. The new rules expand disclosure requirements by requiring a cohesive set of qualitative and quantitative disclosures intended to provide users of financial statements with useful information about the company’s contracts with customers. The disclosures will include information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts.
Spotlight on Industry-Specific Impact
The new rules will have a particularly significant impact on certain industries—including those that commonly sell goods or services in bundled packages or enter into contracts that include variable payment terms, such as performance bonuses or rights of return. For example, wireless providers (which may sell a customer a phone at the same time as a service plan) and software companies (which sell licenses to software along with future upgrades or other vendor obligations) generally recognize revenue only to the extent they have actually received cash and under the new guidance may see accelerated recognition of revenue.
The new rules apply only to revenues from customer contracts related to the transfer of nonfinancial assets. Contracts that remain within the scope of other FASB topics include insurance contracts, leases, financial instruments, guarantees, and nonmonetary exchanges between entities in the same line of business to facilitate sales.
Behind the Revenue Recognition Basics Curtain
The guidance also includes rules for accounting for some costs related to obtaining or fulfilling a contract with a customer—addressing whether to capitalize or expense them. Incremental costs of obtaining a contract (those that wouldn’t otherwise be incurred, such as sales commissions) are recognized as an asset.
For fulfillment costs, the company will apply any other applicable standards (such as those for software or property, plant and equipment). If none apply, the company recognizes an asset from the costs if they meet certain criteria.
Be Sure Your Company Receives 5 Stars for Revenue Recognition
The new guidance is effective for public companies for annual reporting periods (including interim reporting periods within) beginning after December 15, 2016. Early implementation is not allowed for public companies.
For private companies, compliance is required for annual reporting periods beginning after December 15, 2017, and interim and annual reporting periods after those periods. A nonpublic entity may elect early adoption, but no earlier than the public entity effective date.
Although the first applicable reporting period is more than two years away, the rules will require many companies to implement new controls, processes, and systems. The time to begin preparing is now, especially if your company chooses to adjust the results from prior periods and provide the three-year comparison required under retrospective application of the new guidance. Please contact CRI’s CPAs for help getting started—and sit back and enjoy peace of mind.