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Are You Ready for the New Revenue Recognition Standard?

Posted on January 26, 2016 by

Dave Van Damme

Dave Van Damme

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Revenue recognition guidance is changing. Under current US Generally Accepted Accounting Principles (“GAAP”), there are multiple accounting models for revenue and extensive industry-specific guidance which can result in different accounting treatment for transactions of similar economic substance. As a result, the Financial Accounting Standards Board (“FASB”) (and the International Accounting Standards Board (“IASB”) as part of the convergence) developed a new principles-based model for revenue to be recognized based on the satisfaction of performance obligations. This new standard removes industry specific guidance and inconsistencies, and therefore, will enhance financial reporting comparability.

The impact this model will have on companies will vary; however, all companies can expect some level of change. The changes could include more estimates and judgments, revised business processes and controls, or additional disclosures. There could also be indirect impacts on areas such as compensation arrangements and debt covenants.

The standard was issued in May 2014 and since then, certain aspects of the standard have been fine tuned. The effective date for non-public organizations is for annual reporting periods beginning after December 15, 2018.

While the implementation date may seem far away, many industry specialists believe the effort and time associated with implementation of the new standard should not be underestimated. In planning for the new standard, companies should consider doing the following:

  • Learning about the new revenue standard
  • Understanding major changes under the new standard
  • Assessing the impact and implementing the transition

Learning About the New Revenue Recognition Standard

The core principle of the new standard is to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. A company would apply the following steps to achieve this principle:

  1. Identify the contract with a customer
  2. Identify the performance obligations (promises) in the contract
  3. Determine the transaction price
  4. Allocate the transaction price to each performance obligation in the contract
  5. Recognize revenue when (or as) the reporting organization satisfies a performance obligation

Each step above is actually quite detailed and often complex in the standard itself, and there may be times when preparers will have to exercise considerable judgment in applying the model. [View the Accounting Standard Update (ASU 2014-09) in its entirety.]

Understanding Major Changes Under the New Standard

There are some fundamental changes in the new standard, as it is currently written, including some of the more significant areas discussed below.

Disclosures

Current GAAP often results in a simple accounting policy footnote and segment reporting, if significant, for revenue contracts. The new standard includes more expansive disclosure requirements, with the intent of providing users of financial statements more meaningful information about revenue contracts.

Variable consideration

Under current GAAP, accounting for variable consideration can differ significantly depending on industry guidance. The new standard establishes a single model to consider for variable consideration, including rebates, discounts, bonuses, and a right of return. Variable consideration under this model will be included in the established transaction price if it is probable there will be no significant reversal
of revenue.

Distinct transactions

Under current GAAP, goods or services may not be considered distinct revenue under a contract. The new standard will require management to determine if goods or services constitute a separate performance obligation under the contract, and then to recognize revenue as that performance obligation is satisfied (which could result in revenue from distinct goods or services recognized earlier or later than under current GAAP).

Multiple element arrangements

Current GAAP limits recognition of revenue on multiple deliverables to the amount that is not contingent on delivering future goods or services. The new standard will require management to allocate the total contract transaction price to the separate performance obligations based on the relative standalone selling prices, and recognize revenue as the performance obligations are satisfied. This will, once again, potentially result in revenue to be recognized earlier or later than it would have been under current GAAP.

Assessing the Impact and Implementing the Transition

Companies should take the time to plan an effective transition. To begin, companies should perform a high level assessment to determine the major areas impacted. A deeper dive, including a technical assessment of all of the different revenue streams and major contracts should be performed in accordance with the new five-step model. Effective strategizing should be considered at this point, including potential contract renegotiations, tax impacts, and covenant, budget, and compensation or commission implications.

Once the assessments are performed, companies will need to ensure systems are aligned with the new model and identify any changes necessary. With the new disclosure requirements, management will also need to ensure systems capture the information needed to prepare complete and accurate disclosures. Any changes and associated controls will need to be implemented, which will likely require the assistance of companies’ technology and other departments. Companies should consider retaining historical data during the transition for effective retrospective application if needed.

Conclusion

It is critical that companies begin to understand the new revenue recognition standard and consider the impact it will have to avoid surprises down the road. For some, this process, along with implementation, could take multiple years. Companies should consult with relevant internal and external parties, including advisors and accountants, to ensure timely conclusion of any issues encountered and a smooth transition.

Dave Van Damme

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Leading the firm's advisory & assurance group, Dave supports closely held businesses with audits, financial reporting and fraud analysis.

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