Is Revenue Recognition Wrecking You?
The biggest accounting standards update ever has private companies scrambling to comply with new revenue recognition and reporting standards.
If you have clients who run private companies, you might want to ask them to clear
some time on their calendar this summer — and fall, probably. They’re going to need
plenty of time to digest ASC 606, “Revenue From Contracts With Customers.” And
you might too.
At over 700 pages, including more than a few amendments, the landmark revenue
recognition standard update is not only lengthy, but depending on the company,
potentially burdensome. The new revenue recognition standard is not an incremental
change to what public, private, and not-for-profit companies were already doing — it’s
a new approach that, according to Deloitte, frees up “organizations to apply reasoned
judgment and enterprise-specific context rather than highly prescriptive rules.”
“This new standard is radically different than any new accounting standard entities
have ever had to deal with,” says George M. Wilson, director of the SEC Institute, a
specialist in SEC compliance and accounting education. “Previous standards have
had to do with how to make journal entries, which is reasonably objective. This new
standard is broad and principles-based — many have started out looking for detailed
rules only to find out there aren’t any. It’s about finding out how these principles apply
to each individual business.”
For most companies, this means breaking down the choreography of their entire
revenue recognition process — changes can go well beyond an organization’s finance,
tax, and audit functions to force a major heal turn in future production, marketing, and
sales processes. Yes, it’s that big.
It’s all about understanding the new standard and how it fits the business, then building
a new revenue recognition process. And if neither you nor your clients have focused
on this new standard yet, it’s time. At the very least, there’s a lengthy learning curve.
Most private companies will have to do an in-depth analysis of every
combination and permutation of their customer contracts to determine
how revenue is earned today and whether that might change to ensure
they’re ready to apply the revenue recognition standard for annual
reporting periods beginning on or after Dec. 15, 2018 (which equates to
Jan. 1, 2019 for private entities with a Dec. 31 year-end), and interim
reporting periods within annual reporting periods beginning after Dec.
15, 2019. (Public companies were required to adopt the new revenue
recognition standard on the same dates last year.)
In other words, if you’re not knee-deep in review and preparation,
you need to be. Nearly every company will be affected in some way,
but experts say the most analysis and potential change will happen in
the software, construction, healthcare, technology, life sciences, and
Microsoft, for example, made waves last year by declaring it would
adopt the new revenue rules early and adjust previously reported
financial results for 2016 and 2017 based on a decision to book its
revenue upfront for its sales of Windows 10 software to original
equipment manufacturers rather than booking the revenue over a period
of time as an ongoing service. Electric car maker Tesla also stirred
headlines, and the markets, with news that accounting under the new
revenue recognition standard reduced its earnings shortfall and allows
for faster recognition of leased car revenue.
Proponents say the new revenue recognition standard is great because
it will make topline activity in all companies — but particularly in public
companies watched by investors — more transparent because many
businesses have backlogs or revenue not yet recognized from contracts
already signed. Still, many companies will have to revise those values
and/or dates, which will make for reported earnings volatility as
companies adjust their practices.
But before we go farther, how did we get here?
In 2014, after an extensive review that finally united the long-dueling
revenue treatment under U.S. Generally Accepted Accounting Principles
(GAAP) and International Financial Reporting Standards (IFRS), a new
standard of revenue emerged, which the Financial Accounting
Standards Board (FASB) and its international counterpart, the
International Accounting Standards Board (IASB), pledged would
“improve the financial reporting of revenue and improve comparability
of the top line in financial statements globally.”
Previous U.S. GAAP and IFRS revenue recognition requirements differed
and led to different accounting outcomes for transactions that were
economically similar. As FASB describes it, IFRS revenue recognition
requirements “lacked sufficient detail” while U.S. GAAP went the other
way — “overly prescriptive and conflicting in certain areas.”
The new standard addresses something else that’s important — the
digital revolution in global commerce. Many experts believe it was time
for a revenue standard that could accurately measure revenue
recognition across developing industries and contracts signed with a
keystroke on a smartphone. In other words, it allows organizations to
measure revenue as their products and payment systems evolve. But it
will take substantial work at the beginning.
“Is this wrecking business? No,” says Kurt Oestriecher of Alexandria, La.-
based Oestriecher and Co. CPAs. “The standard provides a five-step
process for determining the timing of when to recognize revenue.
Because the standard is principles-based, not every situation will be
addressed. In those instances, companies now have a framework that
requires them to be more consistent in their revenue recognition
practices. This is not the horrible thing it’s been made out to be.”
The new revenue recognition standard affects all entities — public, private,
and not-for-profit — that enter into contracts with customers to transfer
goods or services or enter into contracts for the transfer of nonfinancial
assets unless those contracts are within the scope of other standards
(think leases and insurance contracts). Financial instruments, guarantees
(other than product or service warranties), and nonmonetary exchanges
between entities in the same line of business to facilitate sales to
customers or potential customers are also detailed. The core
principle is “an entity should recognize revenue to depict the transfer of
goods or services to customers in an amount that reflects the
consideration to which the entity expects to be entitled in exchange for
those goods or services.”
While that’s a mouthful, the standard’s guidance offers a five-step
process to determine when and how much revenue should be
recognized. The AICPA condenses these steps in its Financial Reporting
Brief: Roadmap to Understanding the New Revenue Recognition
Standards. Here’s a high-level overview:
Step 1. Identify the contract(s) with a customer.
This is a critical step
considering an entity must account for contracts with customers that
meet certain prescribed criteria.
Step 2. Identify the separate performance obligations in the contract.
A performance obligation is defined as “a promise in a contract with a
customer to transfer a good or service to the customer.”
Step 3. Determine the transaction price.
The transaction price is “the
amount of consideration (for example, payment) to which an entity
expects to be entitled in exchange for transferring promised goods or
services to a customer.” To determine the transaction price, an entity
should consider not only the terms of the contract but also customary
business practices and a slate of other criteria.
Step 4. Allocate the transaction price to the performance obligations.
The guidance states that “if a contract has more than one performance
obligation, an entity should allocate the transaction price to each separate
performance obligation in an amount that depicts the amount of
consideration to which the entity expects to be entitled in exchange for
satisfying each separate performance obligation.”
Step 5. Recognize revenue when or as the entity satisfies a
Accordingly, “an entity should recognize
revenue when (or as) the entity satisfies a performance obligation by
transferring a promised good or service to a customer. An asset is
transferred when (or as) the customer obtains control of that asset.”
Consider Chicago-based Reynolds Group Holdings Limited, a privately
held manufacturer of consumer beverage and foodservice packaging
— including the Starbucks cup you might have picked up on the way to
work this morning. Let’s stick with that cup.
Like most manufacturers, Reynolds historically recognized revenue at
shipment. However, the new revenue recognition standard spurred a
two-year review process of the company’s contracts with customers that
warranted a different approach.
“When we put the Starbucks name on a cup, we don’t have the ability
to sell that cup to another customer. We have no alternative use for that
product. So, we have the right to payment at the time of manufacture,
not shipping, based on our contract language,” explains Rich Tarapchak,
Reynolds’ corporate controller and an Illinois CPA Society member. “You
have to check your contract language very closely against the guidance,
and sometimes that requires you to recognize revenue sooner.”
You have the deadline. You have the standard. But how do you adopt
and implement it in time? Wilson thinks white papers help — not the kind
you download but the kind you write yourself.
“It’s about choosing a couple of key contracts and determining how
the new principles apply to them,” Wilson says, noting that he’s seen
self-authored documents ranging from 20 pages up to an 80-page
whitepaper authored by an agricultural equipment maker on key
The point? To literally go through the thought process and document
how your business functions and how the new standards operate within
your enterprise. “It’s a way to explain your thought process to your
auditors or outside consultants,” Wilson explains. “I did a workshop last
summer sponsored by an auditor with 12 private companies in
attendance, and they were startled by this. Usually it takes anywhere from
three to seven months to manage the transition.”
Wilson offers three steps for getting your arms around the process:
1. Take time to get familiar with the new standard, either alone or with
“I would allow one to two days to do this because
everything you know about revenue recognition is gone. It’s a fresh
start,” he says.
2. Pick a revenue stream (or two) to analyze.
“Take the time to apply what
you’ve learned directly to one of your revenue streams. Get an
example going and work it through,” Wilson says. “It’s not until you do
this that you really understand the extent of the change.”
3. If you need further help, secure it ASAP.
Figure out what resources
you’ll really need to execute the full extent of the revenue recognition
transition within your operation, whether that means bringing in legal,
tax, audit, or industry-specific accounting help.
There’s a parallel learning process for accounting professionals serving
clients, according to Ralph Nach of Chicago-based Epstein + Nach LLC,
a financial reporting consulting and training firm:
• Get instruction immediately to save time.
“If you haven’t gone to at
least a full-day seminar, you’re going to waste time trying to master the
content on your own,” Nach says, referencing the many pages of
guidance on the new standard, much of it amended very late in the
process. “It’s more efficient to take a seminar or course to get up to
speed and ask the questions relevant to the industry group or groups
you serve,” he says.
• Inform your clients now.
“Talk [to them] about steps they’ll need
to take to comply on time and whether they need additional
resources to allow their auditors to maintain their independence,” he
suggests, cautioning that outside consulting services may be
needed, and as Jan. 1, 2019 gets closer, those resources will become
scarce and expensive.
• Analyze data needs.
Conduct an analysis of what data will need to
be generated for proper documentation of accounting judgments and
for accommodating the newly required disclosures. Accessing the
information needed for proper disclosure should be the focus now,
and “process and systems design can come later,” Nach says.
One last point. Wilson says accounting professionals and their clients
should buckle down and learn the new revenue standard now because
another hurdle is coming — new lease accounting standards, which
promise to drastically change how public and private companies
account for leases on everything from office space to copiers.
The document-by-document approach to contracts will have to be
repeated on the lease side and shouldn’t be underestimated. “It’s going
to involve all your little leases, like copiers, machine tools, fiber optic
cables, or cars for executives; anything you rent to get business done,”
Wilson says. “That’s the next thing to look forward to!”