New revenue recognition standard has CPA firm coaching clients for change as 2018 and 2019 deadlines are phased in
“This is not your typical accounting standard change; if you have contracts and you have customers, you are likely going to be impacted”
Approximately 15 years ago, the accounting industry vocalized the need to form a single, unified global revenue recognition strategy. Fast forward to the present where Clayton & McKervey, an international certified public accounting and business advisory firm located in metro Detroit, is aggressively informing clients of the change and coaching them on taking action.
The final revenue recognition standard, which offers two adoption method options, the retrospective method of the cumulative effect method, was announced in May 2014 and takes effect in 2018 for public company financial statements and 2019 for private entities. The time for companies to absorb and implement the changes is now, according to Clayton & McKervey shareholder Julie Killian, CPA, who is leading the firm’s revenue recognition efforts for clients who fall under the privately held deadline.
“This is not your typical accounting standard change, which may inspire yawns and mild irritation on the part of impacted industries,” Killian said. “The new standard switches from a rules-based approach that accountants are used to in U.S. Generally Accepted Accounting Principles (GAAP,) and moves to a more principles-based approach. Gone is the industry specific guidance that provided fairly straightforward methods of recognizing revenue in an entity. Instead, there are very broad guidelines requiring significant judgment to recognize revenue across most industries. Rather than determining which U.S. GAAP standard to apply to a transaction, management must now determine how to apply this single standard to all transactions.”
Different industries will see varying levels of impact from implementation of the new standard. Some of the most significant indicators of change can be determined by contracts that:
- Involve multiple goods and/or services
- Span more than one year
- Change during the contract term
- Have multiple revenue streams, such as a contract providing tooling and production parts
- Are complex, with numerous variables or terms and conditions
- Are not well documented, resulting in data that will be difficult to accumulate
- Are costly to obtain of fulfill, such as contracts involving sales commissions
- Have licenses or royalty agreements
- Have compensation or debt linked to revenue
- Have customer warranties, provide a customer with the right of return or have customer acceptance provisions
“It’s important that businesses start reviewing their contracts, purchase orders and other documentation of a sales arrangement, as the language likely includes implied contracts,” Killian said. “These arrangements with customers should be looked at individually in the context of the new revenue recognition standard to assess how the requirements will affect them. The changes to the standard have vast and far-reaching implications for almost all industries and sectors. If you have contracts and you have customers, you are likely going to be impacted.”
Despite its relative complexity (156 pages in the initial standards update plus subsequent clarifications) the standard has five distinct steps that have to be performed in order to recognize revenue. The five-step plan is to:
- Identify each contract the company has with a customer
- Identify the performance obligations in the contract
- Determine the transaction price for the contract
- Allocate the transaction price to each specific performance obligation
- Recognize the revenue when the entity satisfies each performance obligation
Killian notes that large companies are already speaking out on the challenging efforts to begin complying with the new revenue recognition standard.
“Many publicly traded companies have commented on the sheer volume of contracts that need to be reviewed, not to mention the high number of individual performance obligations that can be found within a single contract or amendments to contracts. It’s daunting,” Killian said.