News Break: Big Changes in Accounting Revenue Recognition Standard
In May 2014, the Financial Accounting Standards Board (FASB) issued a new revenue recognition standard – Accounting Standards Codification Update 2014-09, Revenue from Contracts with Customers. The intent of which was to move from current industry specific revenue recognition into one standard method that would be applicable across industries.
The effective date for application of the new revenue recognition standard will be for annual reporting periods beginning after December 15, 2018, for non-public business entities. Early adoption is permitted for annual periods beginning after December 15, 2016.
When the International Accounting Standards Board (IASB) and FASB started the revenue recognition project, many participants were concerned about the impact it would have in their specific industry. Fret not - the world is not coming to an end.
This is not to say there won’t be significant impact. This new process will, in varying degrees, impact all participants. In fact, ALL participants will now need to go through a 5-step process into order to complete the revenue recognition process.
Step 1: Identify the Contract
This step is easier in industries that historically have used signed contracts as the basis for revenue recognition. However, in order to determine if you have a contract the following questions need to be answered:
· Does the agreement have commercial substance? (Will cash flows change?)
· Does the agreement have approval and commitment of both parties?
· Can both parties’ enforceable rights be identified?
· Are the terms and manner of payment identifiable?
· Is collectability probable?
If the answer to all of these questions is yes, then you have a contract.
Step 2: Identify the Performance Obligations
A performance obligation (PO) is defined as a promise in a contract. Under the new standard, the performance obligation, rather than the contract, is the new basis of measurement for revenue recognition. Distinct POs require separate revenue recognition, which results in separate tracking within the accounting system. A PO is distinct if it can be used on its own, is separately identified from other promises in the contract and has a different pattern of revenue recognition from other promises. Evidence that a PO is not distinct would be if it is interdependent with other promises within the contract, if the contractor provides the service of integrating it with other promises and if the good or service promised significantly modifies other promised goods or services. If you have trouble determining whether or not a PO is distinct, think with a customer’s perspective. Do they see this good or service as having standalone value? Generally, a contract will be one performance obligation, as it involves interrelated goods and services that are integrated by the contractor.
Step 3: Determine the Transaction Price
For some contractors this step has the potential for requiring the biggest change from previous revenue recognition methodology. In determining the transaction price, the new standard requires the contractor to assess the original contract price plus adjustments for variable consideration. Variable consideration (VC) as defined in ASU 2014-9 is a new term but not a new concept. It represents award fees, early completion bonuses, liquidated damages, etc., or the various carrots and sticks that are written into contracts.
When including variable consideration in a transaction price calculation, the new guidance stipulates that the contractor should use either the estimated value approach or the most likely amount approach depending on the type of consideration.
Step 4: Allocate the Transaction Price
As noted in Step 2, most contracts will result in one performance obligation. In these instances, this step is very easy. The entire transaction price determined in Step 3 is assigned to the lone performance obligation identified in Step 2. If there are multiple performance obligations, then the contractor must allocate the transaction price between the POs. The transaction price should be allocated by one of the following methods (in order of priority):
· Standalone selling prices of the various POs
· An adjusted market assessment of the various POs
· Extended cost plus margin of the various POs
· A residual approach
If there is variable consideration included in the contract, and you can determine that it relates specifically to one PO, then it should be allocated specifically to that PO.
Step 5: Recognize Revenue
Once the PO is satisfied at a point in time revenue is recognized.
Regardless of how impacted you may be by the changes noted above, the new guidance stipulates that there will be more extensive disclosures related to revenue. Examples of additional disclosures stipulated include but are not limited to the following:
· Disaggregation of revenue by classification that would be most useful to the users of the financial statements (geography, type of good/service, type of contract, etc.)
· Opening and closing balances of receivables, contract assets and contract liabilities
· Revenue recognized in the period that was previously a contract liability
· Revenues recognized from POs satisfied in previous periods from change orders executed in the reporting period
· A description of the timing of the satisfaction of POs relative to the timing of payment and the impact of the differences in timing on contract assets and liabilities
· Quantitative and/or qualitative information about assets recognized from the costs to obtain or fulfill a contract with a customer
Good news though, relief is provided for non-public companies that allows them to elect not to disclose certain items noted above. If you need assistance, we are here to help. Contact us today for additional guidance related to required disclosures.
See this and other new accounting standards impacting private companies in 2017 and beyond in Marek’s First Quarter 2018 Accounting & Assurance Update and supporting Q1 A&A Appendix.