In August 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2015-14, deferring the effective date of its new revenue recognition standard by one year. But that doesn’t mean companies should relax their implementation efforts. After all, the FASB voted for the delay because it recognized that implementing the new standard is a complex undertaking, and it wanted to ensure that companies had sufficient time for a successful transition.
A Quick Recap
The new revenue standard was originally unveiled in ASU 2014-09, issued in May 2014. Designed to eliminate inconsistencies and weaknesses in existing standards, ASU 2014-09 established a new “core principle” for revenue recognition: “to depict the transfer of 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.” It also outlines five steps for determining when revenue should be recognized. (See the boxout “Recognizing revenue: A 5-step program.”)
A key change is the requirement to identify separate performance obligations — promises to transfer goods or services — in a contract. A company should treat each promised good or service (or bundle of goods or services) as a performance obligation to the extent it’s “distinct,” meaning 1) the customer can benefit from it (either on its own or together with other readily available resources), and 2) it’s separately identifiable in the contract.
Once performance obligations are identified, a company must determine whether these obligations are satisfied over time or at a point in time, and recognize revenue accordingly. The new standard represents a shift to a principles-based approach, so it will require greater judgment on the part of management. The standard requires extensive disclosures, both qualitative and quantitative, about current and expected future revenue.
Originally, for public companies, the new standard was slated to take effect for annual reporting periods beginning after December 15, 2016, including interim periods within those annual reporting periods. ASU 2015-14 defers the effective date to annual reporting periods beginning after December 15, 2017, including interim periods within those annual reporting periods. It also permits early adoption, but no earlier than the original effective date.
As before, companies may apply the new standard retrospectively to each reporting period presented. Alternatively, they may elect to use a modified retrospective approach, under which the cumulative effect of initially applying the standard is recognized at the date of initial application.
Here are things you should be tackling now to prepare for the new revenue standard:
- Assess the impact on how — and when — you report revenue. Apply the 5-step approach to existing contracts to determine whether you’re required to split contracts into separate performance obligations or bundle several contracts into a single performance obligation. Even if your company doesn’t expect a quantitative effect on how revenue is recognized, the internal process will likely be significant. So, while the numbers may not change, the overall thought process will.
- Identify areas in which management will need to rely more heavily on judgment and estimates. For example, if a contract provides for variable or contingent consideration, determining the transaction price will require management to estimate the amount to which it will be entitled and include it in the price only if it’s probable that no “significant reversal in the amount of cumulative revenue recognized” will occur when the contingency or other uncertainty is resolved.
- Determine the nature and extent of required disclosures. The new standard requires additional financial statement disclosures, both quantitative and qualitative, regarding revenues. In addition, upon adoption, companies must make disclosures regarding the impact of the new standard. Make sure your systems are equipped to collect the data you’ll need for these disclosures.
- Evaluate your accounting policies, business processes, information technology systems and internal controls. Are they equipped to collect the information you’ll need to comply with the new standard? Suppose, for example, that you currently track information by contract. If the new standard requires you to separate contracts into discrete performance obligations, or to bundle several contracts together, it may be necessary to update your policies, processes and systems to collect the information you need. In addition, there will likely be impacts to the internal controls over financial reporting that will require updating current documentation and involve controls testing. Disclosures about the anticipated effect of the new standard on a company’s financial position and results of operations may be necessary, as required by Staff Accounting Bulletin (SAB) Topic 11-M.
- Consider the impact on customer relationships. You may want to revisit the way products and services are bundled and priced, or restructure your contracts with customers, to better align your business practices with the way you recognize revenue.
- Look into how other aspects of your business might be affected. For example, changes in the way you recognize revenue may affect your tax planning strategies or debt covenants with lenders. They may also cause you to adjust compensation plans that are tied to revenue. And consider addressing public company disclosures: Companies may want to get an early start in disclosing the methods they will use to implement the new revenue standard and the impact the standard will have on their internal control over financial reporting.
Despite the one-year delay, it’s important to start planning now. Even if you adopt the new standard on January 1, 2018, you’ll need to collect data for 2016 and 2017 under one of the retrospective transition methods. In addition, public companies must disclose the expected impact of the new standard on their financial statements and fine-tune those disclosures as they approach the adoption date.
Recognizing Revenue: A 5-Step Program
Under the Financial Accounting Standards Board's Accounting Standards Update No. 2015-09, companies are required to apply the following steps in determining when to recognize revenue:
- Identify the contract with a customer.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations in the contract.
- Recognize revenue when (or as) the entity satisfies a performance obligation.