Today’s financial world puts a great emphasis on meeting targets. From the perspective of those who run businesses and their employees, it can mean the difference between a large bonus or being let go. From a stockholder’s perspective, it could mean the difference between selling or holding a stake in a company.
The most common measure used to gauge whether one has met targets is revenue, which is why attaining proper revenue recognition is paramount for a business’s success.
Revenue recognition in some instances can be simple. Consider a manufacturer that sells a non-warranty product to a customer. In this instance, revenue is recognized when all four of the traditional revenue recognition criteria are met: (1) the price can be determined, (2) collection is probable, (3) there is persuasive evidence of an arrangement, and (4) delivery has occurred.
Revenue recognition, however, gets complicated when those criteria don’t apply, which is typical in industries like technology, real estate, media and entertainment, construction and health care.
Revenue in these industries is typically contract driven and determined on a customer-by-customer or contract-by-contract basis. In particular, revenue from contract accounting could be subject to the revenue recognition criteria of multiple deliverable arrangements. Under this set of criteria, revenue may not be recognized over the life of a contract in a systematic way; rather, contract revenue could be broken up into segments and recognized when certain milestones or deliverables are achieved.
In the technology and software industries, for example, revenue is recognized when certain segments of a contract are completed.
The most complicated part of revenue recognition for these industries is the valuing of contract segments, which are not always broken out in the contracts themselves.
Given the need for guidance and clarification on existing and new revenue models, the Financial Accounting Standards Board (FASB) developed numerous industry-specific standards for revenue recognition. However, these standards are extremely detailed and have led to inconsistent treatment of similar types of transactions across industries.
To address that issue FASB in May issued new revenue recognition guidelines in step with the International Accounting Standards Board (IASB) to develop a common revenue standard for accounting principles generally accepted in the United States (U.S. GAAP) and International Financial Reporting Standards (IFRS).
The new standard will eliminate many inconsistencies brought on by the industry-specific guidance, particularly with respect to revenue generated from contracts with customers. It will serve as a uniform standard that will supersede most of the previously issued guidance and provide a framework that all industries can follow.
The main premise of the guidance is that companies will recognize revenue upon the transfer of goods or services to customers. Companies will now have specific principles and steps to follow to determine proper revenue recognition.
In addition, expanded disclosure requirements for U.S. GAAP financial statements will add transparency to financial reporting.
Each company will have to apply the new accounting standards to their own specific circumstances. In some cases, the new standards will change the timing of when revenue is recognized — such as when there are contracts with bundled equipment and services, long-term contracts or customer incentives, or when there is licensing of intellectual property. Your company may now have expanded disclosure requirements, or need to change its processes, controls, tracking systems and/or technology used to account for revenue recognition.
You’ll also want to consider business implications such as income tax planning, compensation plans and debt arrangements, all of which could be affected by changes in the timing of revenue recognition.
Although the new standard is not effective until 2017 (for public companies) and 2018 (for non-public companies), now is the time to evaluate potential impacts.Â
Ted M. Lucas and Timothy J. Landry are senior managers in the assurance services division of accounting/consulting firm Marcum LLP’s Hartford office.
