Show Me the Money (and where it goes): The New Revenue Recognition Standards
There aren’t many instances when the accounting industry faces a game changer. But with the new Revenue Recognition Standard FASB has put in place, that’s exactly what every company will experience in its day-to-day accounting practices.
To make sense of the change, we hosted a full day conference on August 16th. Tom Groskopf of the AICPA’s Center for Plain English Accounting, an advocate of private companies and a nationally recognized authority on accounting topics, presented to a crowd of over 120 clients and friends on the new standards. In case you missed the session, below are the highlights.
What’s the Big Deal?
Revenue sounds like a seemingly straightforward concept. Yet, standards, which go into effect for privately held companies for years beginning after December 15, 2018, address the wide disparity in how companies will actually recognize revenue. Disclosure requirements related to revenue recognition have been anemic or even nonexistent. Also, revenue recognition is one of the top 5 reasons nationally for financial statement restatements. Overall, the guidance itself needed improvement.
Requirements under the new Revenue Recognition Standard will:
- Eliminate the transaction and industry specific U.S. GAAP literature on revenue recognition
- Be principles-based and require a great deal of judgment
- Require some level of retrospective or cumulative effect adjustment; organizations will have to assess implementation for potentially one-to-two years back for a comparative financial statement presentation
Also, the core principle will be broken down into five steps:
- Identify the contract with the customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contacts
- Recognize revenue when (or as) the entity satisfies a performance obligation
Sometimes accounting is black and white, and sometimes the nuances behind a standard are critically important for determining how it will affect a company. These new guidelines are all about understanding those nuances. In fact, based on some of our early client conversations, many organizations may be surprised at how this new standard might inadvertently affect their revenue recognition and outlook on operations:
Contract is Key. Existing SEC guidance on revenue recognition focused heavily on the contractual obligations with a customer, and many of these concepts closely align with the new standards. Nonpublic organizations that do not currently align their revenue recognition policies with SEC Staff Accounting Bulletin guidance will have further to travel in aligning practices, interpreting their operations, and implementing the new revenue recognition guidance.
Sales and Marketing. Contracts that affect how organizations are doing business, and how businesses are selling to their customers, are at the center of the new standard. The more disconnected an organization is from knowing what their sales and marketing teams are doing, the more challenging implementation will be. Customer incentives (loyalty programs, variable consideration, rebates, volume discounts, early pay discounts, etc.) may significantly impact the way and the term over which revenue is recognized, and this may impact the timing of when you expense the associated sales commissions based on revenues.
Accounting Systems. Accounting ledger and ERP systems do not have the proper tools that organizations need to track the necessary details to implement this new standard. It is expected that most organizations will need some sort of offline or custom-built tool.
Disclosures, Disclosures, Disclosures. Even if you have a simple operational revenue cycle and this standard will not impact the debits and credits of your world, it will impact your financial statement disclosures. Early adopters have gone from having virtually no revenue recognition disclosures to having 2 to 5 pages of additional disclosures.
The Devil’s in the Details. This new standard is robust. Don’t discount the details as some of these may impact how you implement the new guidance. A few clarifying discussion topics from the presentation include:
- Multi-element arrangements
- Financing components
- Implied promises and customer care (either explicit or implicit)
- Gross vs. Net; Principal vs. Agent
- Capitalized costs; incremental costs to obtain a contract
- Bill and hold arrangements
- Income tax impacts
If all of this sounds complicated, that’s because it is. Revenue is generally the single largest line item on a financial statement and is the highest volume transaction item in the financial records. No two companies are exactly alike, so accurately recognizing revenue requires a deep understanding of the organization and how it conducts business.
FASB has provided a principle-based new standard for revenue recognition. It is time to understand it, get in the game, and start playing.
James E. Merklin?>
CPA/CFF, CFE, CGMA, MAcc
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