In culmination of a project spanning twelve years, the Financial Accounting Standard Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contract with Customers on May 28, 2014. The FASB Standard was issued concurrently with the issuance by the International Accounting Standards Board (IASB) of revenue standard IFRS 15 with the same name.
The ASU creates a comprehensive standard that converges U.S. GAAP and IFRS to provide a principles-based approach to revenue recognition and eliminates existing industry-specific guidance. Consequently, FASB expects entities to recognize revenue more consistently for similar contracts, regardless of the industry in which an entity operates.
Accounting for revenue recognition by both publicly-traded and privately-held entities will be affected by this new standard. Potential impact might be seen in the way customer contracts are structured in the future. Knowledge of the new rules and proactive planning will be key factors to implementing the new revenue recognition standard, as adoption of the standard will be required for all entities within the next few years.
Who will be affected?
The new standard will affect all entities that enter into contracts with customers to transfer goods or services, unless those contracts are within the scope of other standards (e.g. insurance or lease contracts).
Although not all-inclusive, the industries that should expect to experience the greatest impact are:
- Asset management
- Real estate
What is the core principle of the ASU 2014-09?
The new standard provides for a basic principal that “an entity shall recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled in exchange for those goods or services.”
To accomplish its objective, the core standard requires five basic steps:
- Identify the contract(s) with the customer
- Identify the separate performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognize revenue when (or as) a performance obligation is satisfied
These steps appear relatively straightforward and consistent with existing GAAP rules for multiple-element arrangements. However, the application of these steps differs in certain respects from current guidance. Changes within each of the steps are important to the recognition of revenue.
Entities should not presume a simple jump forward to the fifth step and assume the continuation of revenue recognition in a manner similar to previous GAAP or industry practice (as evidenced by the long adoption period).
Entities generally will be required to use more judgment and make more estimates than under current GAAP, which will be highlighted for the users of the financial statements through expanded required disclosures.
What is the impact on long-term contracts?
The new standard requires that revenue be recognized when (or as) a performance obligation is satisfied. The concept of performance obligation milestones established by a contract may not be consistent with an entity’s current revenue recognition policies.
Each performance obligation within a contract is to be treated as a deliverable for revenue recognition purposes. Consequently, management should evaluate each revenue contract to carefully identify each of the performance obligations. This could represent a very challenging process due to the complexity of long-term construction contracts and the necessary judgment involved.
Most companies use the well established percentage-of-completion method (cost-to-cost) to recognize revenue from contracts that progress over time. Under the new standard, the revenue is based on the level of revenue “expected to be earned,” which could include performance premiums (currently disallowed as contingent revenue).
In addition, companies will need to evaluate their existing contracts to determinate if revenue recognition could still take place over time. Revenue recognition may need to be deferred until performance obligations are satisfied by transferring a promised good or service to a customer; therefore, when a transfer-of-control occurs. The transfer-of-control of a good or service could take place at a particular point or over time.
Further, the new standard provides guidance for the accounting of certain costs to obtain or fulfill a contract with a customer. Companies will need to re-evaluate their long-term revenue contracts to verify which costs are allowed to be capitalized under the new standard.
How does a company plan for a successful implementation of revenue recognition changes?
The long implementation period provides for companies to take the time necessary to create an implementation plan prior to the effective dates.
The following planning steps are recommended:
- Ensure your accounting staff is well trained and informed on the new standard
- Evaluate the implications of the change from current GAAP to the new standard
- Establish discussions with external auditors to ensure your adoption approach is accurately achieved and documented
- Evaluate the retrospective application of the new standard and its effects in prior periods
- Consider any changes to be made to existing contracts
- Make any necessary changes to the internal control and IT system to properly capture the standard changes
- Consider any additional necessary financial statement disclosures
- Establish any necessary discussions with company stakeholders (or other financial statement users) regarding the overall impact of the standard changes
When do the new standards take effect?
For public entities, the new standards are required in annual reporting periods beginning on or after December 15, 2016 (that, is fiscal 2017 for calendar year-end entities). Private companies have a delay in adoption of one year (that is, fiscal 2018 for calendar year-end entities).
Andrea Leslie, CPA, is a manager with Daszkal Bolton LLP. She may be contacted at [email protected]
Daszkal Bolton has an experienced team of professionals who can assist companies develop and implement a roadmap to adopt the new revenue recognition standards.