How To Implement The FASB’s Updated ‘Revenue From Contracts With Customers’ Guidelines
Five years ago, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09 entitled, “Revenue from Contracts with Customers (Topic 606).” This new standard became effective for private companies’ annual reporting periods beginning after December 15, 2018. If you haven’t yet implemented these new guidelines within your company and need a refresher on just how to do this, read on.
What You Should Know
As part of the implementation process of these new guidelines, all companies must document their decision-making process, as well as add significant disclosures for those decisions to their financial statements. Because of the technical nature of this guideline, business owners and management should consider an implementation plan with their CPA. Items to consider when beginning implementation include:
- Familiarizing yourself with the five step approach (briefly illustrated below)
- Gathering an inventory of the types of contracts you perform
- Walking through different types of contracts with your CPA
- Determining your method of implementation
- Making necessary changes to operations, systems, processes and internal controls
- Informing stakeholders (owners, users of the financial statements, etc.) of any changes in your reporting and accounting for ASU 606
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The Five-Step Approach
As part of the process, you need to identify revenue streams that have unique characteristics or by product line and address them with the following steps for revenue recognition.
1. Identify the Contract with the Customer
Contracts may be written or oral, but must be identifiable, have commercial substance, and be probable that consideration will be collected. Management needs to consider what has been promised to provide the customer that they have agreed to pay for and how change orders and contract modifications are handled.
2. Identify Performance Obligation(s)
A performance obligation is a promise in a contract to transfer a good or service to the customer. This may be single or multiple distinct promises within the contract. Management will need to consider any material rights created with options to acquire additional goods or services for free or at a discount in the future and evaluate if they will have any uninstalled inventory related to the contract.
3. Determine the Transaction Price
The transaction price is the amount of consideration to which a company expects to be entitled in exchange for transferring goods or services. The transaction price can include the original price of the contract, variable consideration (discounts, right of return, credits, price concessions, coupons, vouchers, incentives, performance bonuses, penalties, etc.), non-cash considerations, milestone bonuses, and any changes to the scope of the contract.
4. Allocate the Transaction Price to Performance Obligation(s)
The total transaction price is allocated to each of the distinct performance obligations in the contract. Management will need to consider and identify factors used to determine standalone selling price of performance obligation and distribute the total price to each performance obligation based on each percentage of total.
5. Recognize Revenue
Revenue will still be recognized utilizing the same cost-to-cost percentage-of-completion method, consistent with current GAAP. Management will recognize revenue when control is transferred to the customer either at the point in time or over time.
This brief outline of the components of ASU 606 should provide a foundational overview and illustrate a basic framework for critical conversations with your CPA. Reaching out to your CPA sooner than later is highly advised as you work toward implementation of the new revenue recognition standard. Should you find yourself needing help, please reach out to us.
By Michaela McGinn (Dublin office)