Revenue Recognition Standards
Companies that generate revenue and apply generally accepted accounting principles (GAAP) need to adapt to the new revenue recognition standards. The new standard replaces the current transaction-specific and industry-specific guidance in recognizing revenue and replaces it with a principles-based approach. The adjustment will require management judgments and may have significant impacts on people, policies, processes, and systems. The new standard is effective for non-public companies in 2019 (public companies in 2018). The clock is ticking and the time is now to assess the impact on your company.
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. 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.
The core principle under the new guidance is to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
The principles of the standard apply a five-step model:
- Identify the contract(s) with customer
- Identify separate performance obligations in the contract
- Determine the contract price
- Allocate the transaction price to each performance obligation
- Recognize revenue when/as performed obligations are satisfied
Implementing the changes may require system changes or an end-to-end automated revenue management system, particularly for multi-location operations, multiple-deliverable arrangements or changing contract terms and considerations. Implementing these changes could require between 12 and 18 months. In some cases, it may be impractical or unnecessary to implement an automated system, and a manual process utilizing technology and tools to supplement your existing processes may be your best approach. Consider the following steps to implement an interim solution or manual process by:
- Evaluating accounting assessments and understand the data from your current systems
- Build a model based on the gap between current data and system limitations with required principle changes
- Communicate and involve third-party stakeholders, particularly auditors, throughout the process
- Execute manual process
- Plan for any necessary long-term automated solutions
Revenue Recognition Readiness Check
Issue 1: Intro to Revenue Recognition - Why Should I Care?
The accounting rule makers adopted new standards on how companies need to recognize revenue in their financial statements.
Issue 2: Revenue Recognition Basics - The 5 step approach
The new revenue recognition standards require the use of a five-step approach in determining how to recognize revenue.
Issue 3: Identify the Contract
Contracts can come in many forms: formal contracts, written agreements, purchase orders, and oral agreements.
Issue 4: Identify Separate Performance Obligations
As you work to implement the new standards, you’ll also need to review and document your customer contracts.
Issue 5: Determine the Transaction Price
In many contracts with customers, the transaction price isn’t always obvious and requires significant interpretation.
Issue 6: Allocate Transaction Price to Performance
Once the transaction price under the contract has been identified, an analysis to allocate the transaction price amongst the performance obligations under the contract needs to be performed.
Issue 7: Recognize Revenue When Performance Obligations are Satisfied
Determine when to recognize revenue on the transaction(s) under the contract.
Issue 8: Construction
In this final step, you’ll need to determine when to recognize revenue on the transaction(s) under the contract.
Issue 9: Manufacturing
Sales can take a wide variety of directions that would result in significantly different revenue recognition timing on a company’s financial statements.
Issue 10: Distribution
Companies that focus their efforts strictly in distribution still need to look at the contractual relationships and understand the uniqueness.
Issue 11: Service
In professional services, revenue might be recognized as you bill your clients for work. But other circumstances might not be so simple.
Issue 12: Nonprofit
Carefully evaluate each transaction because a single transaction may not be entirely a contribution or an exchange.
Issue 13: Footnote Disclosures
With these new standards, many companies will need to add anywhere from a few paragraphs to several pages of disclosures about their revenue recognition policies.
Manual solutions have many complex elements, including navigating accounting, operational and data complexities. Revenue recognition is critical and the new principle-based approach is complex. Companies can’t afford to get this wrong. Additionally, depending on the adoption method (full-retrospective or modified retrospective), quantifying the impact of these standards adoption may require significant effort in determining the impact on the opening balance sheet and/or presentation of financial statements under old standards and new standards. The gathering of data required for this assessment can be voluminous and time-consuming and in some cases extremely difficult due to changes in historical operations, mergers, and acquisitions, or changes in systems.
Given the amount of change required, auditors and audit committees should be involved early and with the entire adoption of the new standard, including the assessment of internal controls surrounding the changes in processes.
With the release of the new revenue recognition standards, alternative reporting options are being given a closer look including a financial reporting framework for small-medium size entities (FRF for SMEs), modified cash or cash basis, and income tax basis. Important considerations need to be reviewed when looking at alternative reporting options.
Talk with your BMF Advisor to discuss the key differences and the related impact on your financial statements. We can also provide assistance in discussing the changes and impact of changes with your bank and other key external stakeholders.