Don’t get too comfortable with your current process for recognizing your business’s revenue. Thanks to the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB), a principles-based standard on revenue recognition has been finalized. Under this new standard, companies in all industries will recognize revenue from customer contracts using a five-step model. This new standard replaces all existing US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) guidance on revenue recognition.
According to the FASB, the core principle of the new standard is for companies to recognize revenue “to depict the transfer of goods or services to customers in amounts that reflect the consideration (that is, payment) to which the company expects to be entitled in exchange for those good or services.”
The Impact Of The New Standard
The new standard is expected to have some impact on revenue recognition for all companies. If your business sells products and services in a bundle or engages in major projects, you could see significant changes in the timing of your revenue recognition. Industries such as telecommunications, software, engineering, construction and real estate have been mentioned as being most affected.
Modifications in how revenue is recognized include:
- Changes to the number of deliverables in an arrangement that revenue must be allocated to
- The way revenue is allocated
- The timing of revenue recognition
- Accounting for contingent revenue and contract costs
The Five-Step Process
Under the new standard, if your business is under contract to provide goods or services to a customer, you will be required to follow a five-step process to recognize revenue. You must now:
- Identify contract(s) with a customer
- Identify the separate performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the separate performance obligations
- Recognize revenue when the entity satisfies each performance obligation
The new standard will require significant management judgment in its application and will require the accumulation of data that may not have been necessary under the previous standard. You may need to develop new processes to capture and document managements’ judgments. Existing contracts may need to be analyzed and some contracts may need to be combined to properly determine revenue recognition under the new model. In some cases, systems may need to be updated or upgraded to capture data needed for additional estimates, judgments and disclosures.
U.S. private companies and organizations are required to apply the revenue standard for annual reporting periods beginning after Dec. 15, 2017, and interim and annual reporting thereafter. While the effective date for the new standard may seem far away, you now need to start evaluating the impact of the standard on their business. A good first step is to determine what new information you may need. Depending on your industry, changes can range from minimal to significant. Getting the systems and processes in place before the standard is implemented will help improve your transition.
This article was originally published in Illuminations: Facts & Figures from people with a brighter way, a Rea & Associates enewsletter, 7/30/2014.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.