Revenue recognition standards will have major impact on financial statements

After many years of discussion, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued the long awaited and converged revenue recognition standard on May 28. This standard has the potential to be one of the biggest changes ever in financial reporting because it impacts virtually every financial statement issued in the world.

In the US, this standard replaces hundreds of unique items of specific guidance for industries on revenue recognition, while for IFRS, the standard provides for revenue guidance, which is currently lacking. Unlike some other complex standards, there are no industry exclusions. Instead there are only a few transactions which are scoped out of the new standard, including insurance, leases, and financial instruments.

Briefly, the new standard requires the entity to consider revenue transactions in five distinct steps:

Identify the contract with a customer

  • An agreement between two or more parties that establishes enforceable rights and obligations, including evidence of agreement of the parties, identification of rights and payment terms, has commercial substance and the entity is likely to collect the consideration in exchange for the delivery of goods or services.

Identify the performance obligations

  • The entity should account for each distinct good or service to be provided based on the terms of the contract; items are distinct if the customer can benefit from good or service on its own and the items are distinct in the context of the contract.

Determine the transaction price

  • The entity determines how much it expects to receive in exchange for the goods or services; if the consideration is variable, the entity must estimate the consideration using a probability weighted method or a most likely amount; the estimated consideration should be constrained to the extent that a reversal of revenue will be unlikely to occur; additionally the entity must potentially consider whether there is a financing component, any non-cash consideration and consideration payable to the customer.

Allocate the transaction price to the performance obligations

  • The entity must determine an estimated standalone selling price for all of the goods or services promised in the contract and, based on the relative values, allocate the consideration.

Recognize revenue as the performance obligations are met

  • As the customer gains control of the good or service, the entity will recognize associated revenue; in situations where services are provided over time, the entity will recognize revenue as the entity consumes the service, or performance enhances an asset of the customer or the entity’s performance does not create an asset with an alternative use and the entity has an enforceable right to payment.

In addition to the above requirements, the new standard addresses costs to acquire contracts and permits deferral of incremental costs to obtain a contract and recognition over the performance period of the contract.

The new standard also contains extensive new disclosure requirements, including qualitative and quantitative information, addressing the nature, amount, timing, and uncertainty of revenue and cash flows related to the contracts, on a disaggregated basis.

The new standard will be effective for public entities and nonprofit entities that have issued or are a conduit bond obligor, for annual reporting periods beginning after December 15, 2016. For all other entities the effective date is for annual reporting periods beginning after December 15, 2017.

The standard provides for two transition methods: a full retrospective method, wherein all periods presented are restated using the new standard or a modified retrospective method in which a cumulative effect change related to initially applying the standard is recognized at the date of adoption, with required disclosures explaining the amount of change for each affected line item in the financial statements and the reasons for the change.

The pervasive nature of this new standard makes it impactful on all businesses. Even if there is no significant change to the bottom line, the need for new accounting systems, internal control procedures, and extensive new disclosures will require resources and attention. The FASB and IASB have recognized this and therefore provided a fairly long runway for adoption. However, for those public companies intending to adopt the full retrospective method, the transition work will begin in 2015 as those statements will need to be restated for the SEC filings.

For more information on this topic, or to learn how Baker Tilly specialists can help, contact our team.