4 things to know about the new revenue recognition standard
March 1, 2019
By Lisa Wigington, CPA
The new revenue recognition standard is here for all public and private entities who use Generally Accepted Auditing standards to prepare their financial statements.
Private companies are required to comply with the new standard that was effective for public companies as of Jan. 1, 2018.
Our experience indicates that many companies are not adequately prepared to implement the standard or even understand its impact on their particular company or industry.
Add to this the fact that revenue is frequently the largest single amount shown in a company’s financial statements and it is clear that the old saying “better late than never” applies. It’s a monumental change in accounting standards for many reasons, but here are four things you need to know about the new standard:
1. This is one of the most significant revisions to the U.S. GAAP in history, effectively consolidating more than 200 pieces of guidance into one comprehensive framework to govern the measurement and timing of revenue recognition.
Furthermore, it shifts from the use of rules-based approaches to a principles-based in that they emphasize broad guidelines to apply to particular fact patterns within an organization. This creates more flexibility but also can require more judgment and documentation of that judgment to support the accounting policies of an organization.
2. It could have a wide-sweeping affect for some operations in the form of changes to financial statements, processes and controls, and information systems. Additionally, each industry will have a unique set of challenges when it comes to converting their revenue streams to the new standard.
For example, manufacturing and construction will need to more succinctly clarify what constitutes a performance obligation defined as a promise to provide a “distinct” good or service and establish a clear timeline for that obligation. Another example is that for retailers, the approach to recognizing revenue from gift cards and rewards programs will be need to be re-evaluated and documented.
Alternatively, we’ve found that certain entities will experience very little change but will be impacted by some of the new disclosure requirements for the notes to their financial statements.
3. There are five steps to revenue recognition regardless of industry:
- Identifying the contract with the customer. A contract does not have to be written if it is common to enter into verbal agreements.
- Identifying the performance obligations within the contract. Judgment often will enter into the determination of whether there is one or more performance obligations under the contract.
- Determining the overall transaction price of the contract. When a contract provides for variable consideration (performance incentives, volume rebates, etc.), companies will have to estimate the transaction price using an acceptable method provided for in the accounting standard.
- Allocating the transaction price between the identified performance obligations. When there are multiple performance obligations, companies will need to identify an appropriate method to allocate the transaction price to these obligations.
- Recognizing revenue as the performance obligations are satisfied. If the performance obligation is satisfied over time, the companies will have to implement processes to track progress.
4. Private companies are not required to use GAAP. Many smaller organizations have used a cash basis or tax basis of accounting for years and are unaffected by this change.
There is an alternative: The Financial Reporting Framework for Small to Medium-Sized Entities (FRF for SMEs). Companies that use FRF for SMEs can essentially bypass the GAAP-based revenue recognition standard and opt for a simpler version that meets their reporting requirements. The simplified framework provides business owners and their business/financial partners with essential information they need to know to measure and report their performance while avoiding the increased complexity that has been introduced into GAAP over time.
Companies must weigh the pros and cons of reporting under a framework other than GAAP. This change in framework would likely require approval by the company’s lending institution(s), bonding agents or other users of the financial statements.
So, what do companies really need to be thinking about? We’ve been advising clients to take a few steps right away if they have not already been preparing for these changes.
- Gaining a base level understanding of the requirements of revenue recognition.
- Identifying the major revenue streams within their organization and the consistency (or lack thereof) in the terms and conditions included in their contracts applicable to each stream.
- Performing a preliminary assessment of the potential magnitude of the change to their company’s financial statements and supporting systems.
- Identifying the resources necessary to implement the new standard and evaluating alternative accounting frameworks if the cost and magnitude of the changes do not align with the current and future reporting needs of their organization.
This article was previously published in the Tri-State BizTimes.