George W. Karpus, The Daily Record Newswire
The Financial Accounting Standards Board and International Accounting Standards Board joined forces to issue a new revenue recognition standard.
While the impact is larger on some industries than on others, this new approach will significantly change the way companies determine when and to what extent revenue is recognized.
With this new revenue recognition standard, we are stepping away from rules and moving toward principles. It may seem that we are going to be playing a bit of a judgmental and subjective guessing game based on five steps outlined in a 135 page principle-based rule. This doesn’t seem too concerning until you learn that the previous industry-specific guidelines were laid out in over 100 different standards, over thousands of pages of which some conflicted. This means less paperwork to review, but leaves us with a lot more to...well, ponder.
The standards were revised with the intention of improving consistency of requirements, comparability of revenue recognition practices, and usefulness of disclosures. But the result is that there is a lot more preemptive planning required of us. Obviously, those of us working extremely hard to protect that hard-earned revenue are little wary of these vague guidelines. After all, we pay our accountants and lawyers to be meticulous and money-conscious for us! The good news is, there’s time to plan.
The application of this new guidance has implications far beyond simply the preparation of financial statements. For accounting, the revenue number is often a determination of company value and affects key financial measurements and indicators. Applying these new standards will affect how and when revenue is recognized, and a dependence on the terms of contracts. The revenue recognition standard will be effective for non-public entities in 2018.
Here are the five steps of this principle. They require a company to use significant judgment during application, including a thorough analysis of the contract and all related facts and circumstances:
(1) Identify the contract with a customer. A contract is defined as “an agreement between two or more parties that creates enforceable rights and obligations.”
(2) Identify performance obligations within that contract that require separate accounting. A performance obligation is defined as “a promise in a contract with a customer to transfer a good or service to a customer.”
(3) Determine the transaction price, which is the amount of consideration that an entity expects to be entitled in exchange for transferring goods or services.
(4) Allocate the transaction price to the performance obligations in the contract that require separate accounting based on their relative standalone selling price.
(5) Recognize revenue when (or as) the entity satisfies a performance obligation. Revenue is recognized when (or as) control of a good or service is transferred to a customer. Revenue can be recognized over time (generally for transferred services) or at a point in time (generally for transferred goods).
Implementing these five steps will affect all industries, some more than others. The new standard is expected to have a significant impact on technology and software companies, whereas it will have a minimal impact on construction and professional services. However, it’s not just industry-by-industry but company-by-company. The way each specific contract with customers is designed will have an impact on how the new rules affect the revenue recognition.
Companies will have to analyze existing contracts to determine the impact of the new principles on current revenue recognition policies and practices. How contracts, warranties and agreements are set up now can affect you in the future. It’s time to enlist a well-advised accountant and talk about the impact that this new revenue recognition standard will have on your organization, and how your CPA can help you navigate these changes and properly respond to them.
—————
Josh Tyree, a partner at Harris & Co., is fielding questions and helping business owners navigate and understand the new standard.
