Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, is likely one of the most important pieces of work we have seen from the Financial Accounting Standards Board (FASB) in years. While the standard goes into effect for nonpublic companies on January 1, 2019, there is much to consider in 2017 to be prepared.
Who Does This Affect?
If your organization issues financial statements — audited, reviewed or compiled — in accordance with generally accepted accounting principles (GAAP), then this new standard affects you and procedures within your internal accounting department.
What Is Changing?
In addition to converging revenue recognition practices under International Accounting Standards Board (IASB) with those under FASB, the standard eliminates weaknesses in reporting and replaces industry-specific GAAP revenue recognition requirements. The change results in more defined steps and criteria for recognizing revenue.
The new standard will impact almost all the contracts with your customers in which you have agreed to transfer goods, services or nonfinancial assets. Specifically, the standard eliminates the concepts of earnings and realization and introduces new concepts, such as transfer (have goods been delivered or services rendered) and entitlement (is consideration fixed, determinable and collectible). Agreements not affected include lease and insurance contracts, financial instruments, certain guarantees and nonmonetary exchanges between entities in the same line of business to facilitate sales to customers or potential customers.
Why Is This Important?
Before looking closer at the changes, you might ask yourself, “Why does this really matter, and why should I look at this now?” Namely, your processes and systems may need to change to adhere to the new requirements. It also will take time to update users of your financial information as to how the new reporting of revenue extends to other agreements, such as loan covenants, compensation formulas or buy-sell agreements.
Even if, after careful analysis and review, no changes are necessary to your organization’s revenue recognition practices, you will see a significant increase in the amount of related disclosures in your statements. Understanding this new standard will be imperative to providing necessary information for those disclosures.
How Is It Applied?
Ultimately the standard results in a five-step process to record revenue:
- Identify the contract
- Identify separate performance obligations
- Determine the transaction price
- Allocate the transaction price to performance obligations
- Recognize revenue as or when each performance obligation is satisfied
What About Verbal Promises Made to Customers?
A promise is a promise. Even a verbal agreement with a customer in the course of ordinary business may be identified as a performance obligation under the new revenue recognition standard. If a performance obligation is distinct and has not yet been delivered, revenue recognition may be deferred.
It’s important to review all promises made to customers — both formal ones written into your contracts and informal ones — to ensure you are identifying all performance obligations under the new standard. If contracts and customary business practices need to be revised, now is the time to do it.
First and foremost, it’s important to familiarize yourself with the new standard. Read articles, attend trainings and talk with your service team. Now is also the time to begin compiling a list of contracts to identify as standard, unique or complex, and to assess differences between the old rules and the new. Determine (1) if your organization will need to recognize revenue differently, and, if so, (2) what effect this new standard will have on all areas of the organization, including revisions to agreements, system updates and tax reporting requirements.
Collaborate with your external and internal accounting teams to help you prepare. Being proactive will help provide a smooth implementation and avoid surprises.
View our timeline to help your organization prepare for the new revenue recognition standard.
Cohen & Company is not rendering legal, accounting or other professional advice. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts and circumstances.