The 5 W’s and 1 H of the New Revenue Recognition Standard
The much anticipated revenue recognition standard has recently been released by the FASB, bringing with it significant changes in how companies will report revenue. Here is a breakdown of the new standard and what it means for you and your company.
Who: This standard affects all companies- public and private – in all industries that either a) enter into contracts with customers to transfer goods or services, or b) enter into contracts for the transfer of certain nonfinancial assets. In short, virtually all companies are affected!
What: The standard provides for a five step revenue recognition model:
Step 1: Identify the contract(s) with a customer
Step 2: Identify the performance obligations in the contract
Step 3: Determine the transaction price (including considering the time value of money if the timing of payments provides the customer or entity with a financing benefit)
Step 4: Allocate the transaction price to the performance obligations in the contract
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation
In addition, the standard addresses the treatment of costs to obtain or fulfill a contract with a customer. Expanded disclosures (including both quantitative and qualitative information about revenue contracts) are also required.
Overall, the new standard necessitates significant management judgment and estimates. In some industries, such as the software industry where a significant amount of revenue has historically been deferred due to lack of fair value evidence, revenue recognition may be accelerated if companies can identify/satisfy specific performance obligations.
When: For public companies, the standard is effective for annual reporting periods beginning after December 15, 2016 (including interim periods within that reporting period). For nonpublic companies, the standard is effective for annual reporting periods beginning after December 15, 2017. Early adoption is not permitted.
Where: The full Accounting Standard Update (ASU) 2014-09 is available for download at http://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176156316498. The ASU is codified in Topic 606 and new subtopic 340-40.
Why: The FASB (Financial Accounting Standards Board) recognized that previous GAAP guidance regarding revenue recognition consisted of generic concepts and various industry-specific guidance. As a result, transactions with economically similar characteristics were reported differently depending upon which concept/guidance was applied. The new standard eliminates these discrepancies by providing a more robust framework applicable for all industries. The new standard also is consistent with the new international accounting revenue standard and eliminates any previous significant differences between GAAP and IFRS in this area.
How: How should companies prepare for the new revenue standard? Delap recommends the following:
• Read the new standard and assess its impact and applicability with respect to your individual company’s revenue cycle
• Begin to develop and collect data to support the various estimates integral to the revenue recognition process
• Estimate the impact of changes in your revenue reporting on your company’s income tax obligations, bonus plans, commissions, and/or debt covenants, and prepare to modify such contracts or tax planning strategies as considered necessary
Delap is happy to assist you and your company with questions and implementation of this new standard.