28 Sep How To Prepare For The New Revenue Recognition Standards
The Financial Accounting Standards Board’s (FASB) new revenue recognition standards will go into effect on December 15th of this year. It’s important to understand why the changes are being made, what those changes are, and how it will impact you.
Why The Changes?
If you’re like most people, you may be wondering why the FASB is making any changes to its revenue recognition standards. But, upon closer examination, it makes logical sense – and is far overdue.
The primary reason why these changes are being implemented is because the current standards for both Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) are complicated and inconsistent.
Case in point: different industries have different recognition standards.
If you are in the SaaS (software-as-a-service) or “Cloud” industry in particular, and offer multi-year, annual, or quarterly upfront payment options, then it is imperative that you recognize the revenue monthly as it is earned.
While the current standards focus on industry type, the new guidelines will focus on the timing of a transaction, the nature of the transaction, and level of uncertainty for contracts. The new standards will (hopefully) address the inconsistencies in current standards, ensure information for accountants is more useful via improved disclosure requirements, and make preparing financial statements easier.
Overview Of New Standards
The FASB has created a five-step system for recognizing revenue, which is intended to be both actionable and straightforward.
Here’s a high-level overview of them…
- Identify the contract with a customer
In the first step, you’ll need to determine whether you have a legitimate contract with your customer, which will be contingent upon it meeting the new FASB standard. Both parties must be committed to the contract, the contract must identify the rights of both parties, payment terms must be specified, an exchange of goods and/or services needs to take place, and you need to be able to collect on the contract.
- Identify the performance obligations (promises) in the contract
Once a contract has been established, you must identify exactly what goods or services you are providing to your customer. You must specify each “performance obligation,” clearly labeling them as distinct items. The regulations state that if a customer can benefit from or use a service or good by itself, or with resources that are readily available, it’s a distinct item. Goods and/or services cannot be considered distinct if they are dependent on other items specified in the contract.
- Determine the transaction price
You will have to define the price of the transaction, and clearly, state what your customer will owe you. You must estimate how much you’ll receive payment-wise, and factor in things like discounts and rebates, weather conditions that might adversely affect the contract, and if the customer will be paying something other than cash, as well as whether the customer will be paying significantly before or after the contract is completed.
- Allocate the transaction price to performance obligations in the contract
If you have a contract that has several different performance obligations, the revenue for each separate obligation should be noted. In other words, if you were to sell the different performance obligations to different customers, the standalone price for each obligation should be defined. If there is a discount that does not apply to every item in the contract, the discount should be used to reduce the transaction price of that specific obligation and reduce revenue for that obligation.
- Recognize revenue when (or as) the reporting organization satisfies the obligation
The new standard states that once control of the transaction has transferred hands, once your customer can use or benefit from the goods or services agreed upon (once you have satisfied your obligations as defined in the contract), you can recognize revenue. If it takes a long amount of time for control over an item to completely transfer, then the revenue should be recognized over that stretch of time.
How To Prepare
The FASB states that the new revenue recognition standards will affect any reporting organization that enters into a contract with customers to transfer goods or services, or contracts with customers to exchange non-financial assets. If this describes your company, how should you prepare for the transition?
The AICPA advises the following:
- Create a task force or assign specific staff members the task of learning how to implement the new recognition standards. Pay close attention to implications for accounting, financial reporting, sales operations, tax, internal audit, IT, and legal departments.
- Evaluate the changes from the old standard to the current standard, determine how your company’s current method of accounting for revenue streams will need to change, and what the impacts will be. Work with your auditor to make sure that your new reporting method is documented accurately and completely.
- Create a plan to retrospectively adopt the new standard, and determine how you will track the differences in accounting for periods that need to be redone.
- Evaluate if any changes must be made to your IT systems, or to software apps, to collect the information needed for the new recognition standard.
- Determine what disclosures you will need to make in the interim before the new revenue recognition standard goes into effect.
- Create an evolving project plan to implement the new standard based upon the preparation you did in the above steps, then start training your staff in the new plan.
- Educate your key stakeholders, such as the board of directors, audit committees, and investors on what the new standard is, and what changes they can expect in your financial statements.
While the new standards will hopefully make things simpler, in the long run, the transition process will probably be a little confusing and overwhelming. The best way to prepare is to educate yourself about the changes that are going to be coming down the pipeline, as well as create a game plan for implementation.