Why You Should Care About the Revenue Recognition Standard

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The effective date for this accounting standard has been potentially delayed due to the COVID-19 outbreak.

The Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09 – Revenue from Contracts with Customers in May of 2014.This standard and its various related amendments bring a far-reaching overhaul to the accounting for revenue and related financial statement disclosure that affects virtually every entity producing financial statements, from the large manufacturing company with multiple contractual deliverables to hospitals, clinics, and even the locally owned corner convenience store. Essentially, the new revenue recognition standard will change even the simplest of operations.

There's much to consider with the implementation of ASC 606 revenue recognition. We've developed resources to help.

Why the Change to the Revenue Recognition Standard?
Many have asked why FASB created a “one size fits all” standard given the diverse landscape of operating entities. The answer is in the question. Companies are identifying increasingly complex and diverse ways to structure businesses, and adding a reactive, continuous flow of revenue recognition standards to address each emerging structure was becoming an impossible task. Lack of or lagging guidance in revenue recognition has a significant impact on lenders, investors, and other users of financial statements. In response, FASB developed a principles-based approach wherein any entity could evaluate their sales structure and related revenue streams to determine the most relevant and consistent way to recognize revenue despite the evolution of the business.
 
Learn more about revenue recognition with our eBook
Five Steps to Understanding the New Revenue Recognition Standards
 
When does the revenue recognition standard take affect?
Initially, the effective date for nonpublic entities was for periods beginning after December 15, 2017, (i.e. December 31, 2018, year-ends). Given the magnitude of the change, FASB then extended the effective date one year to periods beginning after December 15, 2018 and interim reporting periods within annual reporting periods after December 15, 2019.
 

In an effort to support and assist stakeholders coping with the effects of COVID-19, FASB has further delayed the effective date of the new revenue recognition standard by one year.
 
Entities that have not yet adopted ASC 606 can elect to adopt the revenue recognition standard for annual reporting periods beginning after December 15, 2019 and for interim reporting periods beginning after December 15, 2020.

What is required as part of the new revenue recognition standard?
We will be providing a series of articles discussing the five components required for revenue recognition, as well as illustrations to help entities understand what to evaluate when applying the framework to their individual revenue arrangements and transactions. The five components are:

Step 1: Identify the contract(s) with a customer
Step 2: Identify the performance obligations in the contract
Step 3: Determine the transaction price
Step 4: Allocate the transaction price to the performance obligation in the contract.
Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.

Additionally, the new revenue recognition standards may have significant tax implications that will also need to be considered. The new standards may impact the timing of reporting revenue for tax purposes, which can result in additional tax accounting burdens as well as tax filing obligations in the year of implementation.

Here are the tax impacts you need to consider with revenue reconigition.

When should I start planning for the revenue recognition standard?
As many nonpublic entities only issue GAAP financial statements once a year, it’s common for these entities to wait until the effective year of a new standard to start evaluating implementation. While that strategy may have been sufficient for past standards updates, waiting on implementing revenue recognition could result in a significant change in reported revenue because the criteria for recognizing earnings is changing. Contracts may need to be revised, loyalty programs may need to be restructured, and customer credit may need to be reassessed.
Here are five suggestions for how to implement ASC 606 revenue recognition standard:

1. Prepare a complete list of revenue sources
To assess the impact on your entity, the best starting place is to identify where your entity earns its revenues. From the general ledger revenue accounts a complete list of revenue streams can be created. However, ASC 606 goes deeper than revenue streams, so next steps include identifying revenue impacting promises to provide future products or services to customers that may include, but are not limited to, rebate or discount programs, loyalty incentives, warranty programs, coupons and gift cards.

2. Review contracts with customers
For each revenue source listed, the underlying contracts with customers will need to be reviewed. Contracts can have many forms; some may be implicit only providing an invoice, sales order, or receipt on completion of the performance obligation while others could be explicit such as a supply or construction agreements. When reviewing these contracts, an entity needs to consider the performance obligations or promises to deliver products or services to their customers. These obligations could be the delivery of a product or service at a specific time or a group of product or services to be provided over a specified period of time. The timing of the delivery of the performance obligation will determine when revenue is recognized. Entities should evaluate whether the terms in their contracts sufficiently address the delivery of products or services or whether changes are needed to clearly define such terms.

Learn more about revenue recognition with our eBook
Five Steps to Understanding the New Revenue Recognition Standards

3. Review software applications and other information gathering processes
With significant changes to revenue recognition, there could be needs to modify software and other information tracking processes to properly record revenues. Information gathering changes may include assembling a cross-functional group such as marketing and sales in addition to accounting personnel on how promotional programs, coupons, rebates and other future promises to customers are tracked. These future promises to customer will need to be considered when recognizing revenue at the outset of the contract.

4. Determine method of implementation and review financial statement disclosures
The standard has two methods for implementations, including retrospective to all comparative periods presented or retrospective to the current period with a cumulative adjustment at the date of adoption. After selecting an adoption method, there are optional practical expedients to ease the transition by not applying the new standard to contracts complete prior to the date of adoption among other expedients. The adoption method determines the necessary disclosures in the period of adoption, but there are disclosure enhancements that will be ongoing that require new information to be disclosed in the financial statements about how your entity recognizes its revenues. In addition, understanding and documenting an assessment of the differences from the legacy guidance under ASC 605 and new guidance under ASC 606 will aid in the transition and enhanced disclosure requirements.

5. Educate key stakeholders about the standard changes
Implementing a new standard requires a considerable amount of work in the period through the adoption; however, properly applying the standard continues past the adoption date. The key stakeholders need to understand the standard impact on the financial statements, but more importantly how financial statements users, such as bankers or investors, will understand your business and the impacts on how your entity contracts with customers.

 
Understanding the importance of the revenue recognition standard
There is a lot to consider when implementing the revenue recognition standard. Contracts may need to be revised, loyalty programs may need to be restructured, customer credit may need to be reassessed, and information gathering process may need to be developed.

The new revenue recognition standard will take time to implement.

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