Although the effective date is still more than a year out, business owners and Accounting personnel are starting to prepare and ask questions on how the new standard will affect them. While the new standard will have substantial effects on some industries (Construction, Insurance, Not-for-Profit) , others won’t notice much of a difference (simple manufacturing and distribution).
The new standard affects all entities that enter into contracts (including purchase orders) with customers to transfer goods or services. The standard eliminates transaction-specific or industry-specific revenue recognition guidance under current GAAP. You should assume the standard applies to you unless you meet a scope exception. Contracts can be written, oral, or even implied. Scope exceptions include, lease contracts, insurance contracts, financial instrument contracts, guarantees, or nonmonetary exchanges to facilitate sales. The effective date for non-public entities is the annual reporting period beginning after December 15, 2018 (Calendar year 2019). No further changes are expected to the implementation date.
The core principle of the guidance is that an entity should recognize revenue 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. To achieve the core principle, the entity will apply the following steps:
Step 1: Identify the contract 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 obligations.
Step 5: Recognize revenue when or as the entity satisfies a performance obligation.
Under the new standard, revenue is recognized as an entity satisfies a performance obligation and transfers “control” of a good or service to the customer. Control of an asset is the ability to direct the use of, and obtain substantially all of the remaining benefits from, the goods or services. Control can be transferred both over a period of time, or at a point in time. An entity would recognize revenue for a performance obligation over a period of time only if it can reasonably measure progress toward completion during that period.
Each of the 5 steps has its own set of complications and nuances that can get more complicated than they initially appear, specifically if the entity deals with any of the following issues: variable consideration (discounts, rebates, refunds, credits, incentives, etc…), contract modifications, right of return, product warranty, repurchase agreements, bill and hold arrangements. Each of these issues needs to be analyzed further and taken into consideration when applying the 5 step process.
Another significant change to with the new standard will be the disclosure requirements which state that the entity must enable users of the financial statements to understand the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers, more specifically:
- Disaggregation of revenue
- Amounts recognized relating to performance in previous periods
– Information about contract balances and changes
– Information about performance obligations
– Amounts allocated to remaining performance obligations
- Significant Judgments
– Timing of and methods for recognizing revenue
– Determining the transaction price and amounts allocated to performance obligations
**Some of the quantitative disclosures may not be required for Non-public entities.
Entities will have 2 options when it comes to transitioning to the new standard and reporting comparative information:
- Full retrospective (Restate comparative information under the new standard)
- Modified Retrospective (Disclose what existing and new contracts look like under the legacy standards for the current year)
As discussed earlier, the new standard isn’t effective until Calendar 2019 for non-public entities. However, now is the time to start thinking about how the new standard might affect your Company and perhaps even adjusting your contracts now to ensure a smooth transition to the new reporting standard.
If you have question on how the new revenue recognition standards apply to your Company, please contact Mike at (952) 476-7122 or email@example.com.