Doug Houser: From Rea & Associates Studio, this is unsuitable, a management and financial services podcast for entrepreneurs, tenured business leaders and others who are ready to look beyond the suit and tie culture for meaningful, measurable results. I’m Doug Houser.
The Financial Accounting Standards Board has issued what’s being called the most significant revision to the U.S. generally accepted accounting principles revenue recognition standards in history. Chris Roush, a principal in Rea’s Millersburg office and Katie Snyder, a supervisor in our Wooster office, have confronted the changes head on to help business owners understand the new standard while uncovering opportunities for new bottom line growth.
On today’s show, Chris and Katie will explain the five steps of revenue recognition under the new standard, what changes are in store for financial statement preparers, and how the new standard can actually be viewed as an opportunity to look at other areas of potential revenue. That sounds like a mouthful. Welcome Chris and Katie.
Chris Roush: Thanks Doug.
Katie Snyder: Thanks Doug. Thanks for having us.
Doug: Now we’ve got a veteran and a rookie here, and I say that in the podcast sense, right.
Katie: Is Chris the rookie here?
Doug: Despite Chris being the veteran of the firm, he’s actually the rookie podcast guest. Whereas Katie, you’re the veteran. A little different spin here.
Chris: Yeah, long time listener, first time caller.
Doug: Very nice, very nice. As we talk about revenue recognition standards, boy that just sounds overly complex just reading that. I go back to the FASB statements and I used to have some of those memorized 30 years ago. Now I can’t even keep up. What’s going on here with revenue recognition?
Chris: Well, previously there was a lot of different revenue standards for different industries across different industries. There was a lot of disparity between company to company. The new standard gives one set of principles that applies across the board to everybody. The FASB is trying to get a little more consistency, a little more clarity, a little more transparency and more compatibility of financial statements between different companies. That’s the idea behind it.
Doug: Okay. The key verb there was trying. Katie, in your opinion, is that accomplished with this or did we make it more complex?
Katie: In the long run, it will make things more simple because as you go from one industry to the other, they are all under the same exact standards and the same rules while before in the old system kind of, they would come out with specific guidance for specific industries and that kept building so many different rules that as you went from different industry that they were issuing statements that had different building blocks to how they were getting their numbers. Now when you read a financial statement, they are all following the same five principles and five steps to reach that end goal. It’s going to be fun to get there. It’s going to be enjoy the journey, but it’s going to be a journey to get there. In the end, it will be worth it.
Doug: Okay, you mentioned five steps. Chris, can you go over those? Do you know those five steps?
Chris: I can-
Doug: You can recite them by heart?
Chris: The first one is to identify … The standard is for revenue from contracts with customers is the official title. The first step is to identify contracts with your customers. Those can be actual written contracts or oral contracts or just implied by the business and the business type. The second step is to identify the performance obligations in the contract. What is the customer going to get from us in exchange for the third step, which is the transaction price? What have they agreed to pay for it? The fourth step is to, if there are multiple performance obligations within the contract to allocate the transaction price to each of those performance obligations, this is the fourth step.
Then the fifth step is just the timing of the recognition. Contracts depending on what they are can be recognized at a point in time. Revenue can be recognized at a point in time under a contract or over a period of time. Construction industry is a good example of what might be over time recognition because they could have a contract that spans a number of months or even years. Revenue will be recognized over the period of performance of that contract.
Doug: I think obviously in the construction world, a lot of them are used to that sort of thinking anyway.
Doug: You’re seeing certain industries that are more, say, unaware or impacted by these changes.
Chris: I think in our client base, construction is going to be one of the industries that’s impacted the most. There are other like software companies with license agreements and things like that that are a three year license agreement or something that are impacted by the standard. There may not be an actual change or a material change in the recognition of revenue under the standard but the one thing that we will talk about and that all of our clients that prepare GAAP financial statements will see is expanded disclosures with revenue.
Doug: Okay. Talk to me about that, Katie, expanded disclosures referring to footnotes and all of that, that type of thing.
Katie: Yes. This is going to be for all GAAP financial statements. When it comes to the new standards, it is required that revenue is disclosed and broken out between different segments and regions. If you sell a lot to a different state, say you have 50% of your sales in Ohio, 50% in New York, you have to disclose the breakout because how that revenue is generated from a user of the financial statements, those revenues have different risks and circumstances. You have to make sure that the reader of the financial statements are informed. Another area of how they need to be broken out is by different segments. I was working with a company on this and going into it, I was like, “You guys have mainly one product line.
You’re going to be good going into this. I don’t anticipate this having a really big impact.” That was a high level surface. When we actually dug down and looked at the details a little closer and understood the different makeup of their revenue streams, they actually had two different revenue. It was the same product but they had two different really end customers. They’re required to disclose on their financial statements these two different segment lines.
Chris: Private companies have some discretion on how they want to disaggregate their revenue and disclose it. Public companies have more strict requirements as far as disclosure, but our client base will have the ability to decide based on their revenue streams and the users what’s the most useful to the readers of the financial statements as far as how they break it down.
Doug: That made me think for private companies, typically the user, right, maybe their financial institution, maybe their board if they have one or surety provider, maybe another third party, but very, very limited in scope. Can they pass on some of this or there’s no getting around doing this?
Chris: If you are required to have GAAP statements. The first question is, do you have a bank or a bonding company or somebody that is requiring financial reporting under gap? Generally Accepted Accounting Principles. Then you have to comply with the standard. Now for private companies, there are scaled back disclosures from what the public companies are required to have. Still, you have to comply.
Doug: Got you.
Chris: If there is not that requirement, then you might want to consider tax basis reporting or some other financial reporting.
Doug: There again, you go back to the usefulness for the end reader. If they don’t have that information, then how useful is it anyway?
Katie: Do you want to tell the story about your one client that I was helping you with? Chris was on vacation.
Doug: Let’s hear all that. Go ahead.
Katie: Someone in his office reached out to me to help him with this client. I’m going through the checklist trying to understand their revenue recognition and things like that. Then I’m just digging into the details and then all of a sudden I get an email from Chris who’s out on vacation and he goes, “Katie, they’re on tax base statements, we’re fine.” This guidance doesn’t even apply to them. I was just like, oh yeah. That was my … coming out right there.
Doug: Thank you very little, right.
Chris: They had been at an industry conference and they’re presented on the new revenue recognition standard, so they started thinking about it and called us for help. Thankfully, Katie was there to answer the phone while I was out but yeah, I was able to respond to the email.
Doug: They freaked out a little. Interesting.
Katie: That’s what we’ve been seeing with some of our clients that are taking the proactive stance and reaching out to us. The industry is making it kind of, it’s this big change, this big change. Well, let’s relax first, let’s identify if it applies to you. It’s only GAAP statements. If you don’t issue GAAP statements, this isn’t a huge concern. Then let’s go to the next step. Okay. Does it apply to you? Yes. Okay. Let’s go through the five steps, see how they apply, see if you end up in the same spot. A lot of times we’re seeing they are construction and software, as Chris mentioned earlier, are some of the areas where it gets a little muddy a lot quickly. Then let’s go through the disclosures. How does this information need to be presented?
Doug: Sure. Yeah, that makes sense. I mean, really it’s not perhaps as overly complicated at the end of the day in terms of what you’re presenting. It’s just the path to getting there you’ve got to go through a lot of mechanics to determine what’s really necessary.
Chris: Then the disclosures, you disclose how revenue is recognized and also the judgements and assumptions you make to get there. That’s part of the disclosure and why they have to go through those five steps to realize how they are recognizing revenue.
Katie: The most complicated thing about this, Doug, is it’s new. It’s a new way of thinking.
Doug: Sure. Yeah, I keep hearing this term performance obligation. It makes it sound like a bad, old, late night type of movie or something. I don’t know. It’s repeated over and over, oh my gosh, what does this mean? For construction companies, for example, they’re already used to producing a WIP schedule and that’s part of the financial disclosure. Does it change a lot of that really, or is it just kind of some supplemental information beyond that type of stuff?
Katie: Could I walk you through an example? We can maybe do one with construction because they’re unique and then we could do one that’s just a non-
Doug: Let’s do it.
Katie: Like a plain Jane. Let’s say, I was telling Chris I’m going to go order a chainsaw here recently because I have some trees on my property I want to cut down. I go out to the internet, I order a chainsaw. Okay. My written contract with the store is for a chainsaw. What’s implied in that contract from historically buying things from them, things over a certain dollar point, I get free shipping. That’s implied. Right there, my contracts for a chainsaw and free shipping. I have two performance items under this one contract. My contract for the one chainsaw, the two performance obligations are for the shipping and the chainsaws. Let’s say I spend $200 on this chainsaw. Then our transaction price for this agreement is $200 okay, so then let’s go to the fourth step. The way that that transaction price needs to get allocated into the performance obligations, it gets divided between the chainsaw and the delivery because I have really two agreements here.
Doug: Even though there was no true cash cost to the delivery.
Katie: Because it’s free, end parentheses right there.
Doug: The air quotes.
Doug: I love the air quotes.
Katie: Then let’s go to the fifth step where you actually recognize the revenue. When the item gets shipped. That’s the first item of recognition. They’ll recognize the revenue that’s associated with the chainsaw and then upon full delivery, the delivery portion is complete. That’s when they get to recognize the revenue that will get allocated to that. Now there’s a million different variations to that example. That is a plain Jane example.
Doug: It still seems complex to get there.
Katie: It’s a journey to get there.
Doug: There you go. Enjoy the journey. Right?
Doug: As you said, so interesting.
Katie: Do you want me to run through the construction workers?
Doug: Yeah, go ahead.
Katie: Okay, another contracts I am actually in the process of reviewing right now is for the construction and it’s stated in the contract that there are six buildings that will be built. Three apartments and then three garages also. Going through the steps, the piece that I’m getting hung up on right now, and I need to have more conversations with the client here is how many performance obligations are, because depending on the judgment of the company and the end user, I will either have six performance obligations or three. Do you want to take a shot at making a judgment what the performance obligations are there, Doug?
Doug: Right. Well, it depends again, probably how the contract is written. As you indicated, what’s implied. I mean, is it implied that the garage goes with the residential unit or are those truly separate?
Katie: Exactly. You hit right there on the nail.
Doug: Nail on the head.
Katie: The crux of what’s so complicated on this specific example is if they were not building these apartments, would they build the garages? That is the question we have to identify before we figure out, before we can progress past up to on the new standards.
Doug: Chris, when you see stuff like that, does it change the thinking of a client in terms of how they maybe write their agreements in the way they’re doing business? I mean, is that something they should consider?
Chris: That’s one of the benefits that we touched on. There may be some benefits to this new standard. I think that’s one of them that they’re going to be able to take a step back because everybody gets caught up in the day to day and doesn’t really pay attention. It just continues the way it’s always been but this whole force, a step back to look at revenue, how companies are interacting with their customers, what the agreements say, the terms those contracts are, and they can take a look and see if those need to be adjusted or tweaked somehow. I think as we mentioned already, I don’t think there’ll be a big change in maybe how revenue is actually recognized and report in the financial statements, but just the disclosure of how we get there, what all is entailed because it’ll significantly expand. Those disclosures that we’ve seen in the past.
Doug: It’s more visibility, now, do you hear any concern on the client’s behalf? Like, hey, I don’t want to disclose that stuff. I don’t want to tell third party users exactly where my revenue stream comes from.
Chris: I haven’t heard that yet, but that may be a concern. I think as we touched on, public companies had to adopt this standard for 2018 so they’ve already had to disclose a lot of this information, which is a benefit to our clients that are privately held because we can go out and look at the regulatory filings for their industry or competitors in the industry to get an idea of what’s being disclosed, the format and the information that’s being included. Potentially being able to scale that back a little bit since we’re privately held and they have more required disclosures at public companies.
Doug: Now Katie, when exactly this went into effect for 2019, correct?
Katie: That’s correct. Can I build off of something Chris was saying? About how this standard is really going to cause people to take a step back from the whirlwind of our daily activities to actually take a look and question where the revenue is coming from. With that, there’s an opportunity that we’re seeing come up where clients can actually take a look at their revenue, they’re different lines now to take a strategic look at it to see where they want to focus their energy and their resources they have because there’s opportunities there and they just have to… It’s causing them to take a new look at what they see on a day to day and go, oh wait, why aren’t we doing this? Why are we spending time over here on project A when project B is more in line with what we want to accomplish as a company?
Doug: That’s a great point. For those that don’t maybe drill down to that level of detail, they can sort of figure out, hey, we’re really making a lot more money over here than we maybe anticipated or what our intuition tells us but now we really know, we see the evidence.
Chris: Right. Once they start to dig in and actually see the detail behind it.
Doug: Yeah. Interesting. That’s truly, truly a benefit. Any other benefits that you see to this besides more time for us obviously to consult with our clients?
Chris: Yeah, that is a benefit it does because we’re going to be in there talking with our clients about this, getting a deeper understanding of their revenue and their agreements with their customers. We’re going to understand their businesses better, not only to help them implement the standard for financial reporting, but then just to know their business a little bit better and being able to give them advice on decisions. Things they’re interested in.
Doug: Good stuff from that perspective. Not all bad news. Everybody hears new regulatory guidance or something like that. It’s always the initial shudder, but in this case, not so bad really. Good. Any other a client examples that you’ve seen that are impactful or that you foresee for this next year? Big issues.
Chris: We’ve developed that. We have a group within Rea & Associates that’s focused on this and some different industry specifications, so we’ve split some of that up. We’ve developed a client questionnaire that all of our team can take out as we meet with clients to go through the five steps and it will give them an overview of what the standard is. The idea is that we would actually go out and meet with them and walk through it so we can dig into more of the detail. Because the principles are pretty simple at the top level but the devil’s in the details. Once you get in, you start to see what the contracts say and different revenue streams. That’s where the complexities pop up.
Chris: That’s why we like to go be able to meet with the clients and walk through.
Doug: Yeah, it helps to sit down and walk through it. Absolutely.
Katie: Chris mentioned that we have different teams here at Rea working on it and we have one specifically focused on the construction. Doug, I’m going to give you a shout out because you’re putting together a little something in September. Do you want to mention that?
Doug: Absolutely. September 20th, we’ve got an industry forum in Wooster, in fact, but certainly open across the state for attendees and we’ll have CPE available. I know you’ll be speaking there.
Katie: Yeah. One of-
Doug: Enlightening folks a little more.
Katie: Yes. One of the team members who’s specifically focused on the construction impact will be joining us to present at that.
Katie: We’re really excited to present.
Doug: Great stuff. Thanks. Well, good to hear. Thanks, Chris and Katie both for being here. If you want to learn more about the new revenue recognition standard or to hear previous episodes of unsuitable, visit our podcast page at www.reacpa.com/podcast. Thanks for listening to this week’s show. You can subscribe to unsuitable on iTunes or wherever you like to get your podcasts, including YouTube. While you’re there, please leave us a review. You can also write to us at firstname.lastname@example.org. I’m Doug Houser. Join us next week for another unsuitable interview from an industry professional.
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