What is it all about?
The new revenue recognition standard applies to contracts with customers except for those within the scope of other standards, e.g. leases, insurance, etc. The new standard eliminates the lack of consistency in revenue recognition across industries. Therefore, it improves comparability and eliminating gaps in guidance.
The new revenue recognition model is a 5 steps model that guides companies in determining the amount and the timing of when revenues should be recorded. It shifts from the existing risk and reward model to one that emphasizes control. Here are the 5 steps:
- Identify the contract with the customer
- Identify the performance obligation, i.e. the goods and services to be provided to the customer
- Determine the transaction price
- Allocate the contract value to the goods and services to be provided
- Recognize revenues as goods and services are delivered to the customer
The new revenue recognition standard also requires a lot of quantitative, as well as qualitative, information to be disclosed.
When is it effective?
Effective date for public entities is the first interim period within annual reporting periods beginning after December 15, 2017, i.e. 2018 for public companies with December 31 year end; nonpublic entities have an additional year. It also allows early adoption as early as 2017 calendar year.
How is it done?
Companies can select one of the two adoption methods – full retrospective or modified retrospective.
Full retrospective – this requires recasting prior years’ revenues as if the standard has existed from the beginning, i.e. the years shown prior to 2018. This method provides great comparability from period to period which is appealing to investors and analysts and other users of the financial statements but requires more efforts and resources for dual reporting.
Modified retrospective – no recasting is required but companies need to record the cumulative effects of the adoption to beginning retained earnings at the time of adoption. This may seem easier than the full retrospective approach but it also requires more disclosures to improve comparability in a different way.
Why should companies care?
Assessment – Companies should perform assessments to evaluate what kind of an impact this standard will have on their financial statements, if any. Since the new standard’s issuance in 2014, companies that began their assessments reported that the process of assessment was taking longer than they thought. Even companies that didn’t believe that this new standard applied to them still should carry out such assessment to document that it has no impact on them. A lot of these companies found that once they began assessing the impact, the new standard actually have material impacts to them than originally thought.
Implementation – Significant amount of work that needs to be done during the implementation process in order to adopt the standard. Some companies discovered that they will need to change their processes and systems in order to be able to capture the data needed. Some discovered that they will need to involve personnel outside of accounting, e.g. operations, IT, sales, etc. in understanding their contracts with their customers. Some may decide that they will need to create sub-ledger in order to capture the data in their accounting systems.
Reporting – Much like the new lease accounting standard we discussed in our blog in May, this new revenue recognition standard could also have significant impact on certain financial covenants.
Although the 5 steps model may seem easy, the devil is in the details!! We can help you go through the model step by step and identify provisions that really matter when it comes to revenue recognition. Contact us at:
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