Accounting & Auditing Blog

How FASBs New Model for Revenue Recognition May Affect Your Company

In my last blog, I highlighted acquisition accounting. Today, we'll recap what's going on with the recent changes in revenue recognition.

On May 28, 2014, the FASB issued ASU 2014-09, Revenue From Contracts With Customers, which creates a new model for revenue recognition that supersedes most current accounting guidance.  The new model includes the following five steps for entities to perform when recognizing revenue:

  • Identify the contract with the customer
  • Identify the performance obligations in the contract
  • Determine the transaction price
  • Allocate the transaction price to the performance obligations
  • Recognize revenue when (or as) the entity satisfies the performance obligation

It is worth mentioning that the even though the word “contract” is used in the first step, this does not mean to imply that this recognition model only applies to transactions with long legal documents attached to them. 

A contract can be written, verbal, or even implied.  It simply means an agreement between two entities to provide goods or services in exchange for consideration.  As such, this guidance will generally apply to most every kind of revenue earned by an entity.

Performance Obligations
“Performance obligations,” as listed in the second step, are promises to transfer a distinct good or service to a customer. In adopting the new accounting guidance, an entity will need to take an inventory of what types of performance obligations exist in its current and future contracts.  For example, an entity may sell a machine product to a customer that comes with a multi-year service agreement. In that transaction, the machine product and the service agreement would likely be separate performance obligations. However, please note that in in some industries where significant customization of product exists (i.e. software), the separate goods and services in the contract could be so highly interrelated that they would form a single performance obligation.

Transaction Price
The “transaction price” in the third step is the amount of consideration that the entity expects to be entitled to in return for the promised goods or services.  In determining this transaction price, the entity would adjust the nominal agreed-upon amount for any variable fees and for the time value of money (decreasing the present value of the price when payments are to be received in future periods).  This is a change from existing U.S. GAAP, which generally limited the amount of revenue recognized to the amount certain to be received.

Allocating the Transaction Price
The fourth step, allocating the transaction price to the different performance obligations, may be a new process for entities applying this guidance.  In those contracts where there are multiple performance obligations (i.e. the machine product and the service agreement) the entities would need to estimate the relative stand-alone selling price basis of each obligation.  This is a relatively easy process when the entity regularly sells the different performance obligations separately; otherwise it could estimate the price using market information or an expected cost plus margin methodology.

Recognizing Revenue
Finally, the entity would recognize the revenue when the performance obligation is satisfied, which under the ASU is the point at which “control” of the underlying goods or services is transferred to the customer.  This is a departure from the transitional risks-and-rewards model for recognizing revenue of U.S. GAAP.  If there is no singular point at which control is transferred, the entity should determine if control is transferred over time, in which case revenue would be recognized over time in a manner that best depicts the transfer of goods or services to the customer.  As such, the ASU does not permit entities to use a completed-contract method for revenue recognition.

The new revenue recognition guidance in ASU 2014-09 also requires additional financial statement disclosures, including disaggregation of revenue according to the timing of transfer of goods and services (i.e. separately showing revenue for goods transferred at a single point in time from revenue for services transferred over time).  However, many of the disclosures in ASU 2014-09 have practical expedients that make them not required for nonpublic entities.

The effective date for nonpublic entities is annual reporting periods beginning after December 15, 2017 (i.e. for calendar year reporting companies, the guidance would first be applied in the year ending December 31, 2018).  Nonpublic entities may also elect to early adopt the guidance for reporting periods beginning after December 15, 2016.

As you can see, the world of accounting is ever-changing and can be confusing. If you have questions about your business, compliance and reporting or what strategies you can adopt to build and grow your business, contact me via email, phone (440) 449-6800  or leave a comment below.

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