After almost a decade of discussion, analysis and planning, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have issued new rules for how companies report revenue on their financial statements. The new standards will be a boon to investors and other stakeholders because they provide greater visibility into the economics behind a company’s financial statements. The new, stronger guidance aims to simplify reporting and make it more consistent from company to company, industry to industry. All industries will be affected by the changes, but the changes are particularly relevant to software, real estate and other companies with longer delivery cycles.
Taking full advantage of the new flexibility will require careful planning and up-front coordination between management, sales and accounting functions. It’s not too early for companies to begin planning for implementing.
Overview of the Five Steps
The new standards empower management to use greater judgment in recognizing revenue, will eliminate most industry-specific guidance, and increase disclosure requirements. The following is the streamlined five-step process for recognizing revenue:
- Identify the customer contract(s): apply the new guidance to each contract or to groups of related contracts that meet certain criteria.
- Identify the separate performance obligations in the contract(s): account for each promised good or service if they are distinct, or bundle them if together the goods or service meet the contract’s obligation.
- Determine the transaction price: consider variable consideration, constraining estimates of variance consideration, the time value of money, noncash considerations and anything paid back to the customer.
- Allocate the transaction price to separate contract performance obligations: ensure the amount reflects the value of that obligation if it were separate.
- Recognize revenue when/as the entity satisfies each obligation: when the customer has title or possession of the asset, or takes on the risks or rewards of ownership of the asset.
The Good News
Implementation of the new five-step model is still a few years off. Public companies must comply with the new standards beginning in 2017, while private companies have until 2018. The standards will apply to all uncompleted contracts as of the adoption date. The new standards will likely impact companies in every industry and replace or update the often cumbersome generally accepted accounting principles (GAAP) used in the United States and the international financial reporting standards (IFRS) used internationally.
In addition, there are industry groups being formed in the AICPA to analyze how this new guidance affects each industry specifically. This will result in some additional guidance on implementation which should be helpful.
The Challenge for Mid-Size Businesses
These changes may significantly impact the level of detail, amount and source of data small and mid-size companies maintain for each customer and contract. It’s not hard to see that this new level of reporting could affect significant portions of a company’s infrastructure, including policies, procedures, systems, data and people.
Companies with complex contracts or longer delivery cycles will feel the effects more keenly. The industries most likely to see significant changes to revenue reporting include software, telecommunications, real estate, asset management, aerospace, and construction. It should be noted that the new guidance is an update of existing guidance, re-written in an effort to remove the inconsistencies from industry to industry and to make explicit concepts that are merely implied in current guidance.
The new guidance is more conservative in some respects and less conservative in others. For example, revenue under the new guidance is to be recognized only when collectability is probable, which is more conservative than existing guidance. By contrast, variable consideration in the new guidance is an estimate of what the entity reasonably expects to be entitled to, which is less conservative than existing guidance.
It is important to note that there are practical expedients in the new guidance to lessen the burden of some of the requirements. For example, the entity does not have to consider a significant financing component if the period between transferring the goods or services and payment for those goods or services is expected to be one year or less.
Start Planning Now for Best Results
As mentioned above, companies that begin implementation planning now will give themselves the best chances for a smooth transition. Entities can elect one of two alternative transition strategies:
- Apply the standards retrospectively to prior reporting periods, effectively requiring a restatement of revenue for the selected years. This strategy will result in truly comparable financial statements, but it will require considerable time, effort and resources to implement.
- Cumulatively report the effects of the new standard in the year of adoption. This approach is somewhat simpler, but may require closing the books twice. There is a possibility that some revenue won’t get reported and additional disclosures will need to be included in the financial statements.
When selecting a transition strategy, companies should consider carefully what their stakeholder want or expect, the resources available, and the potential benefits of historically comparable financial statements.
Companies should begin planning soon for the transition to the new standard, especially if they plan to apply the standards retrospectively. The approach should be cross-functional and collaborative, likely requiring strong project- and change-management skills of the CFO responsible for ultimate implementation. https://wblcpa.com/new-revenue-recognitions-standards-announced-what-mid-size-companies-should-do-now-to-prepare/Additional resources and outside guidance may be necessary.
Planning for implementation can begin as soon as your team is in place. Assemble a team of leaders from every department that will be affected and consider the following:
- What revenue recognition transition strategy will your company follow?
- Which accounting methods will be affected?
- Is data for transactions accurate and complete?
- Will systems need to be modified or replaced?
- Will employees require training? Who on staff should become experts in the new standards?
- What policies and procedures will need to be updated or established to ensure success?
The new revenue recognition standards are meant to reduce the complexity and improve the consistency of how companies record and report revenue. The process will be iterative and support will be available through the newly established joint FASB-IASB Transition Resource Group (TRG). While there is time before the new standards take effect, companies that begin planning now will ensure the transition is as painless as possible.
For more information about this article, or to discuss your company’s transition strategy, please contact Griselle Umpierre, Audit Senior Manager.