by Pat Deming and Claire Pahlmeyer
Revenue recognition guidance is finally here and requires some thought to be implemented properly. Though released in 2014 and implemented in 2018 for public companies, there are still a number of questions and areas of confusion for private businesses. Implementation for private companies begins for all annual reporting periods beginning after December 15, 2018. Beyond a potential adjustment to the top-line revenue figure, the most widely applicable change of the new standard are disclosure requirements that will impact nearly every financial statement. This article outlines a broad scope of how to think about the new standard and what to ask your accountant.
Topic 606 – Revenue from Contracts with Customers emphasizes reporting on the nature, amount, timing, and uncertainty of revenue. Revenue should be recognized to depict the transfer of promised 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. The Financial Accounting Standards Board has broken this process down into five steps: identifying contracts with customers, separating performance obligations, calculating the transaction price, allocating the transaction price, and recognizing revenue appropriately.
Identifying contracts with customers means defining which revenue contracts fall under the new standard, as not all qualify. To qualify, there must be approval, identification of rights and payment terms, commercial substance, and probable collection. Performance obligations are a new term to Topic 606, operating as a means by which to split out discounts and allocate revenue according to timing differences. All contracts contain at least one performance obligation and require analysis to determine whether goods or services should be bundled. Calculating the transaction price has not changed significantly, except to emphasize the inclusion of variable and noncash consideration. Allocation of the transaction price between the performance obligations introduced in step two is a new concept, requiring possible estimates of the standalone selling price of each performance obligation. Recognizing revenue is, for obvious reasons, the most important step, but also the most complicated. Revenue from different performance obligations within a particular contract may be accrued at different rates and over different durations while previous standards have allowed for more flexible recognition methods.
The guidance surrounding a few components of revenue, in particular, have been adjusted, including accrual of gift cards, warranties, rebates, loyalty programs, and contracts with variable consideration or significant financing, to name a few. Verbal contracts, as opposed to written, pose a distinct risk as there may be different expectations between an entity and its customers. Disclosure requirements have expanded to include a surface-level comparison of revenue accrual by timing or operating category. In addition, contracts open at the end of a fiscal year warrant special attention as revenue accrued to date may be amended.
Assurance professionals at Kernutt Stokes have been tracking the changes in this standard closely and have experience assisting businesses in complicated guidance transitions. To learn more about Kernutt Stokes assurance services, contact Haley Lyons at 541.687.1170.