Are You Ready for the New Revenue Recognition Standard?
Oliver Brooks, CPA, CFO Consulting Partners LLC
On May 14, 2014 the FASB issued the standard ASC 606 Recognition of Revenue from Contracts with Customers. The FASB issued an Accounting Standards update to the Standard (ASU 2016 -10) in April 2016.
The implementation date for the standard is:
- For public business entities, certain not-for-profit entities, and certain employee benefit plan
- Reporting periods beginning after Dec 15, 2017
- For all other entities
- Reporting periods beginning after December 15, 2018
ASC 606 will have a major impact on the reporting of revenue for all entities, public and private that enter into contracts that promise the exchange of goods and services to their customers with a relatively minor impact on some costs associated with fulfillment of the contracts.
The standard is both complex and far reaching. Consequently, implementation is likely to require considerable effort and expertise.
Entities that plan to report GAAP financials would be well advised to consider moving quickly to initiate a thoughtful plan of action to comply with the standard.
OVERVIEW OF THE STANDARD
The following recaps the author’s view of the key guidance in the standard.
The basic economic transaction is the contract between an entity and its customers. The standard address the accounting for the promises embodied in the contract, which it refers to as performance obligations.
The core principle of the standard is that an entity recognizes revenue when goods and services are delivered or fulfilled.
To achieve the core principle the standard promulgates a series of actions that an entity must undertake are:
- Identify the contract with the customer
- Identify the distinct performance obligation(s) in the contract
- Determine the transaction price
- Allocate the transaction price to the distinct performance obligations in the contract
- Recognize revenue when (or as) the entity satisfies the performance obligation(s)
ASC 606 requires considerably more disclosures about revenue. In general, the intent of the disclosures is to enable the reader to understand the nature and amount of the revenue being recognized and the uncertainty of the related cash flows. More specifically the entity shall disclose:
- Disaggregation of revenue
- Contract Balances
- Performance Obligations
- Transaction price allocated to remaining obligations
The standard provides guidance on several other situations that can arise in the administration of contracts. For example (Not a complete recap)
- Measurement of progress completion
- Change in estimate
- Right of return
- Contract modification
- Bill and hold arrangements
- Cash and non cash consideration
Given the complexity of this standard and its impact on revenue, it is incumbent on entities to have a well thought out implementation and transition plan. Some key issues that the plan should address include:
- Financial: Determine the revenue streams that are impacted. Assess the need to review all customer contracts, possibly cataloging them and detailing their performance obligations.
- Review the methodology in place for recognizing revenue and devise an intervention whether interim or final, systematic or manual, that brings revenue recognition into line with the standard
- If the plan envisions significant manual effort be aware of the increased probability of errors and mitigate it with adequate quality control
- Information System: Ascertain the need and /or feasibility of reconfiguring the ERP system to seamlessly produce financial information in compliance with the new standard
- Organization: Communication to internal and external stakeholders. Determine the need for revised guidance to organization units that interface with customers or suppliers with regard to entering into, structuring of and reporting on contracts.
- Transition: Decide on and prepare for full retrospective or modified retrospective presentation for financial statements presented after the implementation date. I.e.
- Full retrospective: Apply the new standard as of the implementation date and, for the prior comparative periods, restate all contracts on the same basis
- Modified retrospective: Apply the new standard as of the implementation date and, for the prior comparative periods, the data is not recast but instead apply a single adjustment to equity at the beginning of the initial year of application.
Companies are advised to begin the process early to ensure compliance. For complex revenue recognition issues, the company may want to consider outside professional resources to assist in the analysis.
More detailed information may be viewed here.