The Financial Accounting Standards Board (FASB) wanted to improve comparability and consistencies across entities and industries, and improve the usefulness of financial statements through enhanced disclosures. So a new standard was issued.
There are two key principles under the new standard to be applied when accounting for revenue:
- Revenue should be recognized in a way that reflects the transfer of promised goods or services to customers. Thus, determining when a promised good or service is transferred to the customer is a critical factor.
- The amount of revenue recognized should equal the consideration an entity expects to be entitled to for those promised goods or services. Determining the consideration in many transactions is not difficult because the amount is fixed and will not change. However, in other transactions where variable consideration may be involved or if there are multiple goods or services to be delivered, that determination can be much more difficult and require judgment.
The revenue recognition guidance includes a five-step approach to serve as a guideline to help entities adhere to the key principles:
Step 1 is to identify customer contracts. A contract is defined as an agreement between at least two parties that creates rights and obligations that are enforceable.
Step 2 is to identify performance obligations, which are promises in a contract to transfer distinct goods or services to a customer.
Step 3 is to determine the transaction price, which is what you expect to be entitled to for providing the promised goods or services to the customer.
Step 4 is to allocate the transaction price to the performance obligations. If there is only one performance obligation, the allocation is pretty easy.
Step 5 is to recognize revenue when or as performance obligations are satisfied.
Revenue is recognized by measuring the progress toward satisfying the performance obligation. If you are unable to reasonably measure progress, then you should recognize revenue only to the extent of costs incurred. Something equivalent to the current completed-contract method is not allowed.
The timing of revenue recognition might be affected under certain types of arrangements that can affect the transfer of control. You will need to consider the effect of things like bill-and-hold arrangements, consignments, obligations to accept returns or give refunds, repurchase agreements, and gift card breakage if you enter into transactions involving those features.
The current revenue guidance is much more rules-based versus the new guidance being more principles-based. The current guidance focuses on when revenue is earned and realizable. When those two criteria are met, revenue is recognized. The new guidance looks at four criteria: (1) whether there is persuasive evidence that an agreement exists, (2) whether delivery of the goods has occurred or the service has been rendered, (3) whether the price is fixed or determinable, and (4) whether collectability is reasonably assured. If all four of those criteria are not met, then revenue should not be recognized.
The new guidance does not include industry-specific guidance as the requirements were written in a way to address all industries.
The disclosure requirements in current GAAP are very limited, and more of the disclosures seem to involve accounting policy-type matters. That is about to change as the new revenue recognition guidance includes several required disclosures involving revenues. Some of the disclosures are optional for nonpublic entities, so one would expect many nonpublic entities to not make those disclosures. However, if nonpublic entities elect not to make some of the optional disclosures, the FASB added other disclosures that nonpublic entities have to make in place of the primary disclosures.
For example, all entities are required to disclose some information about the breakdown of revenue based on whether control transfers over time or at a point in time, as well as qualitative information about how economic factors (such as the types of customers, geographical locations, and types of contracts) affect the nature, amount, timing, and uncertainty of revenue and cash flows.
For nonpublic entities, the effective date is for annual periods ending on or after December 31, 2019.
If full retrospective adoption is selected, the financial statements are presented as if the guidance has been applied to all contracts with customers presented in the financial statements since the inception of those contracts.
If the modified retrospective approach is selected, the guidance is applied as of the beginning of the current year and then to subsequent periods. The prior periods presented in the financial statements, if any, are not restated. The cumulative effect is then recognized as an adjustment to beginning retained earnings. However, it is important to note that if you select this approach, you are required to disclose the amount that each line item in the financial statements is affected in the current period by applying FASB ASC 606 rather than prior GAAP. Thus, you will need to maintain your accounting records under both FASB ASC 606 and previous GAAP during the initial year of adoption.
Some entities have found that the new standard requires changes in their operations, information technology systems, processes, and internal controls. For example, you may need to implement or modify procedures for how information and documentation will be gathered to make required estimates and judgments. Or, you may need to make changes to your automated systems to estimate variable consideration or determine standalone selling prices.
This standard applies to all financial statements prepared in accordance with U.S. generally accepted accounting standards, including reviews, compilations (with and without disclosures) and “preparation” financial statements (with and without disclosures). Some of the disclosure requirements would even apply to non-GAAP financial statements.
The impact of the new standard will vary depending on the nature of your business and types of contracts/agreements (both written and oral) that you have with your customers.
Your W&D engagement team will be having discussions with you regarding the new standard.
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