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The Who, What, Why, and When of the New Revenue Recognition Standard

October 2, 2017
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In 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 606, Revenues from Contracts with Customers, (“ASU 606” or the “Standard”). The implementation guidance is voluminous, totaling close to 1,000 pages. Below is an overview that will help get you up to speed with the new revenue recognition rules.

Who
ASU 606 has the potential to impact a significant number of both publically held and privately owned companies. The Standard is applicable to almost every industry with some industries being impacted more than others. The most impacted industries include: software, construction, health care, technology, life sciences; and areas of entertainment, music and sports.

Why
The Standard is being implemented to provide a comprehensive revenue recognition model for all contracts with customers and to help streamline and remove inconsistencies from current revenue recognition requirements; provide a more robust framework for addressing revenue recognition issues; and increase the usefulness of disclosures on revenue recognition.

What
The Standard’s rules and guidance require a five-step process, or analysis, to determine when and how much revenue should be recognized through a particular measurement date.

The five-step process and brief synopsis on each is as follows:

  1. Determine if a company has a contract. A typical contract will have a few basic elements, including: identifying the rights of the parties; indicating the contract value, indicating payment terms; and, approval by the specified parties.
  2. Identifying the performance obligation(s). What goods/services are the seller providing to its customer? This is where the rules can get complicated, in that, if the contract involves the transfer of more than one good or service, an analysis may be required to determine at what point a customer can use or benefit from the good or service (a “distinct” good or service). If a good or service transferred is considered distinct, the revenue may be recognized. When a contract involves the transfer of a good or service that is highly dependent on a combination of additional contract goods/services that have not been delivered, recognition of revenue may need to be deferred.
  3. Determining the transaction price. For each contract an estimation will need to be made on the amount that is expected to be collected. Certain elements, such as discounts, rebates, and refunds, will need to be taken into consideration. In addition, the seller may also need to estimate variable considerations. That is, changes in the transaction price, which are highly dependent on a certain set of circumstances or an outcome. Variability can be rewarding or punitive from the perspective of a seller. For example, incentives for the completion of the contract performance obligation by a certain date, or penalties for delays.
  4. Allocation of the transaction price. For a contract that has more than one performance obligation, the amount of the transaction price will need to be allocated to each performance obligation, based on a standalone selling price. An analysis of the allocation will include bifurcating the group of goods/services into individual goods/services and determining the prices as if the good/service was sold/performed individually, and not part of a contract “bundle.”
  5. Recognize revenue as performance obligation is satisfied. Essentially the first four steps have built up to Step 5. Revenue should be recognized when transfer of control occurs. Depending on the terms of the contract, this could happen over a period of time or at a point in time (where there is a single performance obligation, or when the goods and services bundled are highly dependent on one another).

A company will need to consider the terms, relevant facts, and circumstance of each contract when applying the Standard. The Standard does allow for the “global” application of the guidance to contracts with similar characteristics if a company can reasonably expect the effects in revenue recognition of applying the Standard will not differ materially from applying the Standard to the contracts individually.

The Standard also requires enhanced qualitative and quantitative note disclosures related to contract prices, including prices allocated to unrecognized performance obligations, and significant judgments used and estimates made related to the recognition of revenue. 

When
The Standard’s rules go into effect for annual reporting periods beginning after December 15, 2017, for public companies and December 15, 2018, for private companies.

Implementation of the Standard may require significant time, resources and judgment, including tax considerations, changes to company software, and employee training.

UPCOMING WEBINAR
Join us on Thursday, November 2, 2017, at 11:00am for the first in a series of webinars on revenue recognition titled “The New Revenue Standard – Are You Ready?” designed to help you navigate through this important change to financial reporting.

Click here for more information and to register!