New Revenue Recognition Rules, Do They Apply to You?
August 28, 2018
Q: What happens in 2019?
A: The new revenue recognition guidance is effective for most, non-public companies (public companies started earlier). If your business earns revenue, this guidance applies to you!
What’s Required to Recognize Revenue?
The ASC 606 Revenue from Contracts with Customers rules (FASB ASU 2014-09) introduced the accounting world to a new five-step model for recognizing revenue in 2014. For the most part, it replaces the old earned and realizable GAAP language for revenue recognition. Following years of discussion, it is time for businesses to act.
ASC 606 Revenue from Contracts with Customers is a principles-based approach, which is common with standards found outside the United States. The new rules apply to all industries and aim to recognize revenue at the time a good or service transfers to a customer. In order to record revenue under the new model, you must work through the following steps:
Step 1: Identify the contract
Step 2: Identify the performance obligations
Step 3: Determine the transaction price
Step 4: Allocate the transaction price to the performance obligations
Step 5: Recognize revenue
Although the steps seem easy, the guidance covers how to evaluate and apply each step listed above. See this simple example:
Garth walks into Joe’s Jitters for a cup of coffee. Garth orders coffee, pays for the coffee, and leaves with coffee within a few minutes.
Under the new guidance, you would evaluate the transactions as follows:
- A contract exists based on Joe’s Jitters customary business practice as both parties will receive value. In this case, Garth will receive coffee and Joe’s Jitters will receive payment/money.
- The performance obligation is the delivery of coffee, at which time the benefit (coffee) transfers.
- The transaction price is clearly posted in the store, and Garth paid for it.
- The purchase price can be allocated to the sale of the coffee, as that was Garth’s benefit as a customer.
- Joe’s Jitters can recognize revenue upon the satisfaction of the performance obligation.
Is Your Business Ready to Comply?
Consider all your business’ revenue streams and the contracts (verbal, written, or implied) under each of those revenue streams. Some of your customer contracts may be for goods, or for services, or for both goods and services, and the new guidance covers each situation. Contracts vary and may have extension options, cancelation clauses, payment schedules, delivery schedules, rights to return if certain standards aren’t met, etc. All of these situations influence when you record revenue from your customers. Do you know how the new standard applies to your revenue streams and your business contracts?
Digging into the Revenue from Contracts with Customers standards can be a daunting, but necessary, task. As an advisor, I urge business owners to take the time to educate themselves on these standards prior to the end of 2018. At least, they should confirm that their financial team is aware of the changes. It may be helpful to meet with an accountant to map out a strategy for complying in 2019. Be ready with a list of revenue streams and contracts to help make your time with your accountant effective.
Do You Need an Audit or Review?
Does your business require a financial statement audit or review? You could perform the analysis and decide you don’t believe a financial impact on your business exists. However, if you need an audit or a review, you should be ready to provide the following to your accountants:
- An analysis of your revenue contracts, including a conclusion of how the new guidance applies
- The information required to meet the expanded financial statement disclosure requirements
- You may have a financial impact and will need to decide which of the required methods you will use in 2019 to get started
If you haven’t performed the analysis, you may incur costs that you weren’t expecting related to your audit or review. Looking through contracts takes time so start early!
It is our mission to share change that may affect our clients. At Delap LLP, we’re committed to bringing you superior service and guidance that may impact your business. If you have any questions on the Revenue from Contracts with Customer rules, please contact our team today at (503) 336-4599.
Please visit the AIPCA Revenue Recognition website for additional information on ASU 2014-09 including:
- Updates to ASU 2014-09
- Industry-specific guidance
- Guidance on getting started with the new rules
- Helpful articles and other info.
A full text of ASU 2014-09 Revenue from Contracts with Customers (Topic 606) is available online through the FASB website.