By Carol Wagner, CPA, Principal
The new accounting standard for revenue recognition is finally here! It’s officially referred to as ASU 2014-09 – Revenue from Contracts with Customers. FASB issued the final revenue recognition standard in May 2014.
The foundation for the changes in revenue recognition rests in principles-based accounting, moving away from the industry specific revenue recognition rules we have been implementing for many years. For example in the tech industry, current software revenue recognition rules are rooted in SOP 97-2 (1997) and multiple deliverable rules were expanded in 2008 and 2009. According to the American Institute of Certified Public Accountants (AICPA), the new core principle for all industries requires revenue recognition, “to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.”[i]
The new standard identifies a five-step process for recognizing revenue. Though it may seem fairly straightforward on the surface, applying the five-step process to your revenue streams may take a significant amount of time and thoughtful consideration. Additionally, your company’s contracts may need to be modified once all the intricacies of the standard have been considered.
Five Step Process
The five-steps are:
- Identify the contract with the customer – Contracts can be written, oral or implied but must create enforceable rights and obligations. A contract must identify the rights of each party and payment terms regarding the goods or services to be transferred.
- Identify the performance obligations – If goods or services are distinct, they should be accounted for separately if they could be sold separately and the customer receives separate benefit from them. Bundled services can be combined into one performance obligation as well as a series of goods or services that have the same pattern of transfer to a customer.
- Determine the transaction price– This includes an assessment of the terms of the contract and the customary business practices. The standard discusses complexities involved with variable consideration which include discounts, refunds, credits, price concessions, incentives, or other similar items.
- Allocate the transaction price – The transaction price must be allocated to each separate performance obligation. The assumption is that each performance obligation has a stand-alone selling price, and if that is not obvious, it must be estimated.
- Recognize revenue when or as performance obligations are satisfied – This occurs when the transfer of control occurs. This concept varies from the previous concepts of transferring risks and rewards of ownership.
As for privately held companies, implementation of the new revenue recognition principles is required for years beginning after December 15, 2017.
Upon issuance of the standard, FASB identified three key points:
- Required disclosures have been expanded. The items on the new disclosures will include: contract assets, contract liabilities, remaining performance obligations, the information on the future pipeline of revenue and the assumptions used in the accounting estimates related to these items.
- Certain industries are affected more than others. As hinted above, the tech industry is definitely one of the industries affected significantly by the new standard. This is no surprise as it is one of the industries that relied heavily on industry-specific revenue guidance. The concept of VSOE for software is gone. Allocating sales price as used with multiple deliverables may still be part of the estimating process.
- FASB does not expect to change the transition date but there will be transition guidance issued. In addition, numerous resources will be available on the FASB’s Website under the Resource Revenue Recognition Group.
If your company belongs to the affected industries, ASL can provide assistance on the implementation process. Look for further articles on the topic as well as seminars.
[i] American Institute of Certified Public Accountant, The FASB/ISB Revenue Recognition Accounting Project. Web. <www.ifrs.com>