Revenue is a key performance indicator and considered to be of critical importance to many users of financial statements.
U.S. Generally Accepted Accounting Principles (GAAP) contain multiple, industry specific revenue recognition rules that sometimes result in different accounting treatment for transactions that may be economically similar. Furthermore, revenue recognition guidance for companies following GAAP is different than guidance contained in International Financial Reporting Standards (IFRS), making it harder to compare financial statements.
To try to fix this problem, the Financial Accounting Standards Board (FASB), which establishes GAAP, and the International Accounting Standards Board (IASB), are nearing completion of a multi-year project to create a single revenue recognition model that will be applied across all industries and will be consistent for both GAAP and IFRS.
Proposed rules aim to provide a more robust framework for revenue recognition; remove inconsistencies of existing requirements; improve comparability; and provide more useful information to financial statement users.
The final rules are expected to be issued later this year, but the earliest the standards will likely become effective are for annual planning periods beginning Dec. 15, 2016 for public entities, and a year later for non-public entities.
The basic concept outlined in the most recently issued draft proposal requires a company to apply a five-step process to determine appropriate revenue recognition:
1. Identify the contract with the customer.
2. Identify the separate performance obligations, or goods and services promised within the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the separate performance obligations.
5. Recognize revenue when a performance obligation is satisfied.
While the five steps appear straightforward, application will require significant judgment.
Contracts that contain multiple performance obligations will create considerable complexity.
The draft regulations contain various indicators rather than distinct criteria intended to guide companies in identifying performance obligations. Companies will have to consider the indicators and apply judgment in making their determinations of when the delivery goods and services should be bundled rather than accounted for separately.
The new standards may impact the timing of revenue recognition. There may be situations when revenue recognition is delayed under today’s standards due to collectability concerns or other unresolved contingencies. In certain instances the new standard will allow for earlier recognition.
The new standards will also contain both qualitative and quantitative disclosure requirements that are more extensive than what is required by current GAAP. Companies will be required to disclose revenue by contract type and reconcile beginning and ending contract assets and liabilities. Any remaining performance obligations will also be disclosed along with costs incurred to obtain or fulfill contracts.
Disclosures will also address qualitative factors and judgments impacting the timing of revenue recognition.
Companies that currently follow industry specific revenue recognition guidance, whose contracts contain multiple performance obligations and provide for variable consideration, or who currently satisfy performance obligations over an extended time period should pay particular attention to the new standards.
In some cases, the new revenue recognition model will yield similar results to current accounting practices. In others, timing of revenue recognition will be impacted and, in some cases, accelerated.
Companies should also consider the need to compile historical and other data that supports their judgments and estimates, and evaluate whether their current systems will require modification.
While the effective date of the new standards may still be a few years off, particularly for non-public entities, all companies should become familiar with the new rules when they are issued later this year, and begin planning for implementation.
Marcus R. Harwood is a partner at West Hartford accounting firm BlumShapiro.
