On May 28, 2014, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued their final standard on revenue from contracts with customers. FASB released this standard as Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers. The ASU creates FASB Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers, and at the time it is effective will substantially replace ASC 605. The ASU outlines a comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. According to FASB Chairman Russell Golden, “The revenue recognition standard represents a milestone in our efforts to improve and converge one of the most important areas of financial reporting. It will eliminate a major source of inconsistency in generally accepted accounting principles (GAAP), which currently consists of numerous disparate, industry-specific pieces of revenue recognition guidance.”
Revenue from Contracts Update
Under the new standard, companies will recognize revenue to depict the transfer of goods or services to customers in amounts that reflect the payment to which a company expects to be entitled in exchange for those goods or services. Companies would recognize revenue through a five-step process:
- Identify the contract with the customer.
- Identify the performance obligation(s) in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligation(s) in the contract.
- Recognize revenue when (or as) the entity satisfies a performance obligation.
Examples of how a company could be impacted by the new standard are below:
- Existing contracts may need to be analyzed for certain additional performance obligations.
- Tax changes caused by changing the timing and amounts of revenue, expenses, and capitalized costs may require adjustments to tax planning.
- Systems may need to be updated or upgraded to capture data needed for the additional estimates, judgments, and disclosures.
- Inclusion of variable consideration in the transaction price prior to resolution of contingencies.
- Requirement of extensive disclosures.
- More comprehensive guidance for transactions such as service revenue and contract modifications.
- Guidance for multiple-element arrangements has been enhanced.
- Capitalization of contract costs based on certain criteria that may be different from current practice.
- Potential changes to companies with long-term contracts and the ability to recognize revenue over the life of the contract.
- Bill and hold arrangements revenue recognition requirements will apply to all entities (not just SEC registrants).
Many other potential changes could impact your company depending on current accounting practices and industry.
The new standard applies to public and nonpublic entities as well as not-for-profit entities. The standard will take effect for public companies for annual reporting periods beginning after December 15, 2016, including interim reporting periods. For nonpublic companies, the standard will take effect for annual reporting periods beginning after December 15, 2017, and interim and annual reporting periods thereafter.