Who Moved Your Cheese? How New Accounting Standards Have Changed How Your Business Measures Revenue
Sales, the most easily understood element of all commerce has been redefined by the accounting regulators. On May 28, 2014 the Financial Accounting Standards Board Issued (ASU) 2014-09, Revenue from Contracts with Customers. The standard will eliminate the transaction and industry-specific revenue recognition guidance under current U.S. GAAP. So why the change and what does this mean for my business, you ask? I’ll try to answer these basic questions and give some background and considerations to how U.S. businesses will account for sales with this very important change.
As background, the FASB and IASB, worked for over ten years on this standard which is principles based and eliminates industry specific guidance that had been developed over decades. Changes in how we account for revenue is driven by a need to improve comparability among financial statements globally in the world marketplace. In addition this is part of a longer term goal of converging accounting rules between the U.S. (FASB) and the rest of the world (IASB).
The new Five Step Dance for Revenue Recognition
The new standard’s overarching principle is that companies should recognize revenue to characterize the transfer of goods or services to clients in an amount that reflects the consideration to which the company expects to be entitled to in exchange for those goods or services. In order to apply this principle, the new standard lays out the following five steps (aka a “Dance Routine”) companies will be required to perform:
- Identify the contract with a client – The contract is an “enforceable rights and obligations” document that may be written, provided orally or implied by a company’s customary business practices.
- Identify the separate performance obligations in the contract – In the contract a performance obligation is a promise with a client to transfer a good or service. The guidance provides a series of criteria for determining if the good or service is distinct based on contractual language.
- Determine the transaction price – The transaction price is the amount of consideration a company expects, excluding amounts collected on behalf of a third party, in exchange for transferring promised goods or services to a client. When determining the transaction price, a company will consider the effects of variable consideration, the time value of money, noncash consideration and consideration payable to the client.
- Allocate the transaction price to the separate performance obligations in the contract – The Company will allocate a reasonable amount of consideration to each separate performance obligation by determining the standalone selling price of the good or service at contract inception. If the standalone selling price is not observable, a company may estimate it by considering all reasonably available information such as market conditions, industry specific factors, and information about the type of clients.
- Recognize Revenue when or as the company satisfies the performance obligations – Revenue will be recognized when a performance obligation is satisfied through the transfer of a promised good or service to a client. Goods or services are transferred when the client obtains control.
How Does this Change Affect Your Company?
The new revenue recognition standard goes into effect for public companies in 2017. While early adoption is not permitted, retrospective application is allowed. A benefit or curse of the change is that many of the complex, industry specific rules governing revenue recognition standards will no longer apply and comparability among companies will be easier for investors. Since the standard is principles based this is less specific guidance, so CFOs will need to make some decisions on allocation over a contract term to allocate or recognize revenue.
In a survey by CFO Magazine, 50% of CFOs indicated they will expend “a great deal of” or “moderate” effort to understand the new accounting rule. * CFO Survey in September 2013.
Accounting processes will likely need to be reviewed and altered in order to address the new standard and some of the changes. The change is far reaching in terms of the affected industries including: Software publishers, Manufacturing, Telecommunications, and any company that has multiple elements in its client contract. The impact will be mixed with companies being able to recognize revenue faster and others having to defer revenue to later periods.
Time value of money is also something that companies need to consider as it is directly related to the transaction price. Lastly, all this estimation will require expanded footnote disclosure so financial statement readers will understand how your company is recognizing revenue. We are advising our clients to evaluate contracts now and consider modifications or upgrades to existing accounting systems to properly capture the data required to meet the new requirement.
Please contact us if we can answer any questions about how these changes may impact your accounting technology applications or if you want to change your dance partner with technology.
– Software Delivered as Promised. No Surprises.