Revenue is a critical measure for entities and their stakeholders. Company management, shareholders, lenders, analysts, investors, and regulators utilize revenue to monitor a company’s financial performance and general financial health.
After years of deliberations with the IASB to improve the accounting for revenue and seek convergence in this area, on May 28, 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606).
ASU No. 2014-09 establishes a principles based approach for accounting for revenue from contracts with customers based on a five-step approach laid out in Topic 606, Revenue from Contracts with Customers. ASU No. 2014-09 represents significant changes to the current guidelines on revenue recognition and largely supersedes the existing industry guidelines for revenue recognition in the Codification.
The recognition and measurement guidelines in ASU No. 2014-09 are based on key principles:
- Revenue should be recognized in a way that reflects the transfer of promised goods or services to customers; and
- The amount of revenue recognized should be equal to the consideration that the entity expects to be entitled to for those promised goods or services.
ASU No. 2014-09 has several immediate effects on companies. For instance:
- Companies must consider their existing contracts and identify any features or terms that may require additional analysis under the five-step approach. For instance, a contract with variable consideration requires more analysis to determine the transaction price than a contract with fixed consideration. As another example, contracts that provide customers with both a good and a service must be assessed to identify the separate performance obligations.
- Companies must evaluate their ability to collect and maintain the data necessary to comply with the standard given their processes and systems. For example, companies may track information at the contract level. Under the new standard, a company may have to either aggregate contracts or separate a contract into parts in order to account for revenue. In addition, the transitional methods in the standard involve retrospective application, which requires companies to gather information about past and outstanding contracts.
- Companies must determine where the standard requires management to make additional judgments, including estimates. In general, the standard requires more judgment from management than under prior guidance because it represents a shift from a detailed rules based approach to a principles based approach. Companies must put processes and controls in place to make these judgments and adequately support them through documentation. In the U.S., an entity’s estimates may be scrutinized by the SEC or other regulators.
- Companies must review the nature and amount of disclosures required under the new standard to evaluate whether they collect the required information. Companies may wish to begin creating a draft of these disclosures.
- Companies must consider whether the changes to the accounting for revenue will affect other areas of the companies’ operations, such as their tax planning strategies, debt covenants, and compensation structures.
- Companies may wish to reconsider the legal structure of their contracts with customers. The substance of a contract, however, takes priority over the contract’s form.
- Companies may reevaluate how their contracts with customers are priced. For instance, a company may decide that its operations will be more manageable going forward if the company updates its contract pricing to better align the timing of billing and the timing of revenue recognition under the new standard. For example, telecommunications companies often provide customers with a phone with a new service agreement. Historically, these companies have recognized revenue for both the phone and the service over time as the service is provided. Under the new standard, they may be required to separate the phone and the service into separate performance obligations and recognize certain revenue upfront when the phone is transferred to the customer.
- Companies may also wish to prepare an analysis of how the new standard will affect the company’s bottom line. This analysis will not only give insight to management, but also prepare the company to communicate with stakeholders regarding the potential effects of the standard on its results.
- Companies that expect changes to the timing or amount of their revenue recognition may want to start thinking about which transition method to use. The transition methods available are:
o A retrospective approach with optional practical
expedients; and
o A retrospective approach under which the cumulative
effect of adopting the standard is recognized at the date of initial application.
This is an excerpt from the special report:
An Overview of the Revised Accounting Model for Revenue Recognition, provided by Thomson Reuters Checkpoint.
Click here to download this free report in its entirety.