New Revenue Recognition Rules to Affect Financial Reporting for US Companies
By John Troyer, Ciuni & Panichi Inc.
Does your client know what is in their customer contracts? They will need to. With new revenue recognition rules, this has become increasingly more important for US companies.
Financial reporting in 2019 for privately held US companies (2020 for interim periods) will be subject to new revenue recognition guidance. Publicly held US companies have already adopted the Financial Accounting Standards Board (FASB) Accounting Standards Codification 606, “Revenue from Contracts with Customers” (ASC 606). This was first announced in FASB’s Accounting Standards Update 2014-09 and subsequent amendments. It is a significant conceptual change from current practice and requires careful consideration for US companies and practitioners who are used to more specific rules-based criteria.
This principle-based guidance is similar to revenue recognition standards under International Financial Reporting Standards (IFRS), thus requiring significant judgment to interpret customer contracts. However, bear in mind there are some differences. So, use caution if you have a client that reports under both US generally accepted accounting principles (US GAAP) and IFRS (e.g., a US subsidiary of a foreign multinational company that uses IFRS for group reporting with local reporting under US GAAP, or vice versa.)
For simple point-of-sale retail transactions, revenue is realised when goods or services are delivered to the customer. The process gets more complicated for long-duration, multi-element contracts, sales that include incentives for customers with poor credit, bundled services, or those contracts with built-in discounts or performance bonuses.
The core principle of the guidance is that an entity should recognise revenue to depict the transfer of promised goods or services to customers in an amount that reflects consideration to which the entity expects to be entitled in exchange for those goods or services.
To apply the new revenue recognition standard, an entity will need to take the following steps:
- Identify the 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.
- Recognise revenue when (or as) the entity satisfies a performance obligation.
In anticipation of these steps, right now, privately held US entities should be reviewing their contracts with customers and identifying the performance obligations included in the contracts. ASC 606 applies to all revenue streams and also addresses the accounting for incremental costs of obtaining a contract and the costs to fulfil a contract.
Revenue should only be recognised to the extent that it is “probable” the entity will not have to make a significant reversal in the future. Variable consideration such as rebates, discounts, bonuses, and right of return should be factored into the transaction price. If customer payments are expected to be received over a period greater than one year, calculating the time value of money must be considered.
Generally, revenues must be recognised over time if any of the following are true:
- The customer simultaneously receives and consumes the benefits.
- The client’s performance creates or enhances an asset that the customer controls.
- The client’s performance does not create an asset with an alternative use to the customer and the client has an enforceable right to payment for performance completed to date. Otherwise, revenue is recognised at a point in time.
While the above concepts may seem straightforward, significant judgments may be required. It is likely that more than just the accounting department will need to be involved. Sales and contracting processes may need to be reconsidered. Operational management and legal counsel may have to assist the accounting department in determining when performance obligations are met. Also, the information technology department may need to modify systems to capture and record information in compliance with the new standards.
Prudent companies will begin thinking about these changes before the end of the year. There is a significant amount of implementation guidance out there from the FASB, the American Institute of CPAs, and others. Public company information for similar companies who have already adopted the rules can be reviewed. However, bear in mind that public company disclosure requirements are more comprehensive than those required for privately held companies.
Given that revenue is often the largest item on the income statement, it is not surprising the new rules will require more disclosure. Increased disaggregation of revenue data will be required. The new standard requires qualitative and quantitative disclosures to provide a full understanding of customer contracts, such as contract balances, performance obligations, remaining performance obligations, significant judgments and estimates, and policy decisions.
Many privately held US companies will be uncomfortable providing this much information in their financial statements. There are some elections for private companies to not provide certain disclosures. They should work with their practitioners to make sure their disclosures meet minimum requirements.
A goal of the new rules was to create an effective and universal way to recognise revenue, regardless of industry and/or jurisdiction. However, the new rules will affect some industries more than others. The new approach will be a major change for companies in the real estate, software, and telecommunications industries. Interestingly, the formally named percentage of completion method utilised for construction companies will likely remain appropriate under the new rules if a construction contract is deemed a single performance obligation. However, the completed contract method may not be if revenue should be recognised over time using an input or output measure as described in ASC 606. Judgment will be required.
Please note that these new rules affect US GAAP but can also have an impact on income taxes if the same revenue is reported as taxable income. The new guidance may accelerate taxable income in certain situations.
The FASB is optimistic that the new rules will create a better methodology for recognising revenue. They believe investors and other financial statement users will benefit from the increased disclosure of financial information. While these are lofty goals, it may be a challenge to implement them. This will be especially true for private companies with limited accounting personnel. This may result in additional work for practitioners to assist them along the way.
John TroyerGGI member firm
Ciuni & Panichi Inc.
Advisory, Auditing & Accounting, Tax
Cleveland (OH), USA
T: +1 216 831 7171
Published: GGI Insider, No. 103, September 2019 l Photo: Pissanu - stock.adobe.com