Risk Insights The Revenue Recognition Standard for Private Companies
MORE THAN FOUR YEARS AGO, in May 2014, the Financial Accounting Standards Board (FASB) released a new set of accounting standards that was poised to make waves for many years to come. The new standards detailed in Accounting Standards Codification (ASC) 606, Revenue from Contracts with Customers, supersede almost all industry-specific guidance pertaining to revenue recognition. To comply with generally accepted accounting principles (GAAP) going forward, public and private entities in all industries must comply with ASC 606 when recording their revenues from customer contracts.
Due Dates PUBLIC COMPANIES SHOULD HAVE already conformed to the new standard, as it was effective for all interim and annual periods beginning after December 15, 2017. This means that public entities filing on a calendar-year basis should have implemented the new standards beginning with their March 31, 2018, quarterly report. Private entities and most nonprofits were given an additional year to comply. They must follow ASC 606 beginning with the first annual report for years beginning after December 15, 2018, and all interim reports for fiscal years that begin after December 15, 2019. The FASB provided such a long implementation period because it recognized that companies would have to institute significant changes to their operating paradigms. To comply, at a minimum, they would have to revise how they collected data, tracked sales and recorded revenue. Even though these paradigm shifts may be drastic, the FASB promised the changes would result in more easily comparable financials. Instead of each industry recording revenue differently, all companies would inspect their contracts using the same lens. The resulting financial statements should be comparable across companies in the same industry, and even across different industries.
The Five-Step Model ASC 606 OPERATES using a five-step model of recognizing revenue. Before they can recognize revenue, organizations must take these five actions, in this order: Step 1: Identify the contract with a customer. A contract is a legally binding agreement, written or implied, between two parties to provide goods or services.
The Revenue Recognition Standard for Private Companies Step 2: Identify the performance obligations in the contract. Performance obligations identify the steps that each party takes to complete the transfer of goods or services. Within one contract, there can be one or many performance obligations. To be identified, they must be distinct and separate from the others. Step 3: Determine the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services. The payment terms (fixed, variable, payable in installments, etc.) should be unambiguous. Step 4: Allocate the transaction price to the performance obligations in the contract. The transaction price should be allocated to each performance obligation previously identified based on their relative standalone selling price. If the exact cost of each promise is unknown, an estimate is acceptable. Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation. Entities should recognize the associated revenue allocated to each performance obligation as they are satisfied and control of the good or service has transferred to the customer.
Private Industry Concerns EVEN THOUGH WE HAVE KNOWN about this new standard for years, implementing it has not been simple. Some of the requirements will be difficult for private organizations to implement. Many organizations struggle with the following aspects of the new standard: •
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Valuing performance obligations – Determining value for each obligation is not always simple. For instance, under the new revenue recognition standard, allowing the customer an option to purchase additional goods or services could be a separate performance obligation. Quantifying the additional goods and assigning a portion of the original contract price to those units can be difficult, and many private entities do not have the resources necessary to fulfill this requirement.
The Revenue Recognition Standard for Private Companies
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Budget – With the change in revenue recognition comes the need to adjust projected revenues in budgets. Significant variations in timing could change budget assumptions as companies plan for 2019.
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Compensation and metrics – Measures for performance-based compensation and key performance indicators have the potential to change significantly. Companies should ensure compensation programs recognize the differences expected with the new standard.
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Systems requirements – Private companies are more likely than public companies to rely on outdated or partially manual systems. Error-prone processes that have worked for a company for years may suddenly become unworkable, because they cannot track each contract and performance obligation. Switching to a new system can be costly and timeconsuming.
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Income taxes – Income taxes will also be affected by ASC 606. If revenues are recognized differently on the books, they may also be recognized differently for tax purposes. Understanding the relationship between cash receipts and book recognition will be key.
Disclosures ASC 606 REQUIRES more robust disclosures than the old guidance. Disclosures themselves are nothing new to those who follow GAAP, but the new standard requires more disclosures than ever before. Private entities are given a bit more leeway, but many will nevertheless choose to disclose some of the following common quantitative and qualitative information: •
Contracts – One of the key requirements of ASC 606 is its requirement to disaggregate revenue into meaningful classes. For example, revenues can be grouped based on pricing structures, types of good or service provided, contract duration or even the geographical region of the completed contract.
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Contract balances – Contract balances can either be presented on the balance sheet as a separate line item or in the notes to the financials. The related disclosures should explain any significant changes in these contract balances. For instance, if the entity determined that estimated revenues from a prior period changed, it would need to disclose the expected impact of the revised amounts in the current period.
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Performance obligations – The disclosures should detail assumptions the company has made about its performance obligations, including how the entity satisfies its obligations, the methods used to determine when an obligation has been met, inputs or assumptions used when testing to see if an obligation has been met, and so forth.
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Transaction price – Significant payment terms should be disclosed, as should the rationale for how warranties and returns are handled, assumptions used when estimating variable consideration, and any other judgments made about the contract price.
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Transaction price and the remaining performance obligations – The estimated value of the remaining performance obligations should be detailed, as well as any collection imbalances. For example, a customer may pay in equal installments over the contract period, but the performance obligations may not be met in the same manner. This dissonance should be disclosed.
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The Revenue Recognition Standard for Private Companies Sample Timeline PRIVATE ENTITIES HAVE REPORTED that ASC 606 was more difficult to implement than they had anticipated, and this could be because the steps to full adoption require a significant amount of time, money and manpower. A suggested timeline for implementation is as follows — note that some of these tasks overlap.
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Scoping and Impact Analysis: September 2018–March 2019 Define business goals, identify revenue streams and consider policy changes Process Design: October 2018–April 2019 Perform a detailed review of contracts, pinpoint specific changes to processes and draft initial disclosures Implementation: December 2018–June 2019 Establish final accounting policies, finalize changes in systems and processes, and calculate necessary transition adjustments Adoption: January 2019–July 2019 Be comfortable certifying that the entity is in compliance with ASC 606
In Conclusion... THE TIME TO ADOPT ASC 606 is today. Do not wait any longer to prepare or get comfortable with the rules; now is the time for action. To help make your adoption easier, we recommend that you work in reverse. Determine what a successful implementation will look like, then work backwards to create a timeline for implementation. Contact Weaver with questions, and we can steer you in the right direction.
CONTACT US Jody Allred, CPA, CISA, CITP, CGMA Partner, Risk Advisory Services jody.allred@weaver.com
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Disclaimer: This content is general in nature and is not intended to serve as accounting, legal or other professional services advice. Weaver assumes no responsibility for the reader’s reliance on this information. Before implementing any of the ideas contained in this publication, readers should consult with a professional advisor to determine whether the ideas apply to their unique circumstances. © Copyright 2018, Weaver and Tidwell, L.L.P.
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