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6 Things to Know about the New Revenue Recognition Standard

May 2, 2017

All companies aim to generate revenue, and while all accounting standards updates require consideration, few will impact as many entities as ASU 2014-09, “Revenue from Contracts with Customers.”

According to the Financial Accounting Standards Board (FASB), “Revenue is an important number to users of financial statements in assessing an entity’s financial performance and position. However, previous revenue recognition requirements in U.S. generally accepted accounting principles (GAAP) differ from those in International Financial Reporting Standards (IFRS), and both sets of requirements were in need of improvement.”

The goal of the new standard is to eliminate issues of inconsistency with companies’ application of the previous methods of reporting contract activity and create one set of revenue recognition principles that can be applied across all industries. The new standard also aims to provide more useful financial statement disclosures, and consideration of individual performance obligations within contracts and how revenue with those obligations is recognized.

Here are the six most important things to know about ASU 2014-09:

1. Be familiar with the effective dates

As with most pronouncements, the effective date differs for public and non-public companies.  Public companies are required to adopt the new standard for annual periods beginning after December 15, 2017. This means that the majority of public companies will be required to follow these new rules starting in 2018. Non-public companies are required to adopt in annual periods beginning after December 15, 2018. This means that the majority of non-public companies will be required to adopt in 2019.

2. Know your options for the methods of adopting the new standard

The methods of adoption available to entities are:  full retrospective adoption and modified retrospective adoption.

Full retrospective adoption involves applying the new standard to all periods presented in a financial statement report, as if the standard had been in effect since the inception of all contracts presented in the financial statements.   This method also requires significant disclosure about the impact on the financial statement line items that changed as a result of the retrospective application.

The modified retrospective application involves applying the new standard only to the contracts active at the opening balance sheet date of application. The cumulative impact of initially applying the new standard is presented as an adjustment to the opening balance of retained earnings in the adoption period. It should be noted that no contracts are “grandfathered,” meaning that all active contracts as of the effective date are subject to the new standard.

3. Study the five-step model

The standard applies a five-step model to determine how to account for revenue earned under a contract:

  1. Identify the contract with a customer
  2. Identify the separate performance obligations in the contract
  3. Determine the transaction price
  4. Allocate the transaction price to the separate performance obligations
  5. Recognize revenue as each performance obligation is satisfied

4. Know what constitutes a distinct performance obligation

A performance obligation is simply a promise to a customer, within a contract, to transfer a good or service. Occasionally, contracts contain multiple performance obligations. If a contract contains multiple performance obligations, the new standard requires determination of whether the various performance obligations are distinct from one another. A distinct performance obligation is one that is not an input needed to create an end product, nor does it substantially change or customize another good or service promised within the contract. Typical long-term contracts are unlikely to include multiple performance obligations.  However, multi-phase and master contracts should be evaluated for this condition.

5. Consider the impact the new standard will have on transaction prices

The transaction price is the amount of consideration to which the entity expects to be entitled in exchange for the transfer of goods or services. The transaction price is also the incremental amount of revenue recognized for satisfaction of a performance obligation. The transaction price can be fixed or variable, depending on whether and how it is impacted by collectability concerns, discounts, rebates, refunds, penalties or credits. Under the new guidance, any discounts or potential future returns of sold goods should be included within the transaction price and initial recognition of revenue. For example, if a sandwich shop offers a “buy five sandwiches and your sixth is free” promotion, the impact and frequency of providing the free sixth sandwich should be included in the calculation of revenue earned from the sale of the first five sandwiches. The revenue recognized on each of the sandwich sales, including the sixth sandwich, would be the same amount. Warranties and rights to return goods will be treated similarly when considering the initial recognition of revenue.

6. Be aware of the changing disclosure requirements around contracts

Substantial changes to footnote disclosures are required under the new standard. Disaggregation of revenue by product line, geography or services provided will be required, as well as disaggregation by the timing of revenue recognition. Other new disclosures include narrative descriptions of open performance obligations, when they are expected to be satisfied, the significant payment terms, and any variable consideration associated.

Revenue, and the proper accounting for revenue, is vital to the success of any business. Be sure to take the time to understand the new standard, and consider the potential impact that the new guidance will have on your business.

All content provided in this article is for informational purposes only. Matters discussed in this article are subject to change. For up-to-date information on this subject please contact a Clark Schaefer Hackett professional. Clark Schaefer Hackett will not be held responsible for any claim, loss, damage or inconvenience caused as a result of any information within these pages or any information accessed through this site.

Guidance

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