Revenue Recognition Standards Implementation – Deadline and Alternate Option
The Financial Accounting Standards Board’s (FASB) new revenue recognition standards will not only affect public companies, but also many private companies whose lenders or investors require them to follow generally accepted accounting principles (GAAP). If your organization is one of these and has a calendar year-end, the standards become effective starting in 2019.
If you haven’t yet dug into an assessment to understand the impact this will have on your financial statement, know that these analyses take time to research and prepare so additional time will be needed to properly review this. Procrastination is not your friend when considering how best to move forward. If you have already done a preliminary assessment or decided you don’t want to spend the time or money to adopt the new standard, do you know all your options to avoid moving forward with this?
Why is this new standard needed?
A primary goal that we’ve heard from FASB is to shift away from the previous rules-based approach to revenue recognition, which varied significantly by industry and moves towards a principles-based approach, which applies more broadly. The new standards apply to most customer contracts across numerous sectors, including high-tech, retail and manufacturing. Several specific types of transactions, such as lease and insurance contracts and some financial instruments, are excluded.
A fundamental principle behind the standard is that organizations should recognize revenue “to depict the transfer of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” FASB has outlined a five-step process for applying this principle:
- Identify the contract(s) with the customer. Several criteria must be met for a contract to exist. One is that the parties must have approved the contract be able to identify the payment terms. In some cases, companies might even need to seek legal counsel to understand if a contract even exists.
- Identify the performance obligation(s) in the contract. A performance obligation is a promise to deliver a good or service to the customer. For example, the sale of a product and the sale of installation of that product may be two separate and distinct performance obligations.
- Determine the transaction price. This should account for, among other factors, variable consideration, a significant financing component or a noncash component.
- Allocate the transaction price to the performance obligations in the contract. If the contract includes more than one performance obligation, the transaction price should be based on the relative stand-alone price of each good or service.
- Recognize revenue when (or as) performed obligations are satisfied. When an organization satisfies the performance obligation over time, it can measure its progress in one of two ways:
- The input method recognizes revenue based on inputs used, such as labor or machine hours;
- The output method recognizes revenue by measuring the value to the customer of the goods or services transferred. This could be handled, for instance, by identifying the milestones reached.
If you use GAAP, the new revenue recognition standards likely will affect your organization’s financial statements, tax obligations and loan agreements. (Yes, you heard right! GAAP might impact how you report revenues on your tax returns, too.) They also may require changes to your firm’s accounting processes and IT systems. Your BMF Advisor can assist in your process of evaluating the impacts of the new standard. Whether you do the work yourself or outsource it, it is critical to keep your accounting team (internal and external) in the loop so that you don’t have any unpleasant surprises when you close out your books for 2019.
But this is not the endgame – we’re seeing more and more companies considering alternatives to GAAP to avoid adopting this new standard, as well as some of the other major standards coming in the next few years (leases, credit losses). Before considering alternatives to GAAP, you really need to consider a few things:
- Who is your audience? Ultimately, you want to ensure that the financial statements provide information that is useful to the readers of the financial statements. Step back and consider who uses the financial information and are there special needs for those users.
- Are you looking to sell or go public in the foreseeable future? If so, perhaps staying with a GAAP financial statement might be your best option, as the parties that would use your financial statements might not want to have to convert your financials to a GAAP basis for purposes of their assessments of value.
- Do you have contractual provisions requiring GAAP financials? It is very common to see bank loan documents that require the debtor provide them with GAAP financial statements; however, if you address GAAP alternatives with your bankers, they may be willing to modify their agreements to provide for a specific alternative reporting structure. What about sureties? If you have bonding requirements, you might need to have similar discussions with sureties to confirm they would be willing to accept an alternative.
Which GAAP alternatives are worth considering?
The best alternative would be the Financial Reporting Framework for Small- and Medium-Sized Entities (FRF). The FRF was introduced by the AICPA in 2013 to provide a comprehensive basis of accounting – that would not be constantly re-evaluated and changed – so that users of financial statements could see more consistency in their financial picture and not worry about constantly changing standards. Below are a few examples of differences between GAAP and FRF:
- Market value accounting – there are several instances where market value adjustments are required under GAAP with significant footnote disclosures (such as interest rate swaps, hedging, etc.), but under FRF these are retained at historical cost.
- Impairment – under the FRF, fixed assets and goodwill/intangibles do not need to be assessed for impairment, whereas GAAP requires impairment assessments. GAAP also requires separate accounting for goodwill vs. other identifiable intangibles, whereas FRF does not.
- Uncertain Tax Positions – GAAP requires an annual assessment of uncertain tax positions (UTP) along with other ancillary impacts such as potentially writing down deferred tax assets for such positions and footnote disclosures. The FRF does not require any assessment of UTP.
Your BMF Advisor can help you evaluate the pros and cons of moving to the FRF so that you can decide whether this methodology best fits your needs.
James E. Merklin?>
CPA/CFF, CFE, CGMA, MAcc
About the Authors
Stay up-to-date with the latest news and information delivered to your inbox.