When there are changes in accounting regulations, most companies usually have one of the following reactions:
- What now?
- How is this going to impact my company?
- Maybe if I ignore it, it will go away.
Unfortunately for small businesses, this new revenue recognition standard will impact businesses of ALL sizes, even smaller ones!
What do you mean, “New Revenue Recognition Standard”?
In May 2014, the two major accounting governing bodies (US and International) issued a joint standard on revenue recognition to address many concerns surrounding the inconsistencies and complexities in accounting for revenue transactions. These standards evolved into what we now call ASC 606, “Revenue from Contracts with Customers”.
The effective dates for when the standards will take effect is as follows:
- For public companies – must be compliant by December 15, 2017
- For non-public companies – must be compliant by December 15, 2018
What are the Major Differences Between the Old and New Rules?
How Disruptive is the New Standard?
As an effort to provide more guidance to the accounting community, the American Institute of Certified Public Accountants (AICPA) has created 16 industry task forces to assist entities and auditors as companies implement the requirements of the new standards.
What are its Core Principles?
ASC 606-10-05-3 states: “The core principle of this topic is that an entity recognizes revenue 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.”
In other words, there are five steps that should be followed in accordance with ASC 606 to recognize revenue:
Step 1: Identify the Contract(s) With a Customer
A contract is an agreement between two or more parties that creates enforceable rights and obligations. The guidance in this topic applies to each contract that has been agreed upon with a customer and meets specified criteria. In some cases, this topic requires an entity to combine contracts and account for them as one contract. This topic also provides requirements for the accounting for contract modifications.
Step 2: Identify the Performance Obligations in the Contract
A contract includes promises to transfer goods or services to a customer. If those goods or services are distinct, the promises are performance obligations and are accounted for separately.
Step 3: Determine the Transaction Price
The transaction price is the amount of consideration in a contract to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer. The transaction price can be a fixed amount of customer consideration, but it may sometimes include variable consideration or consideration in a form other than cash.
Step 4: Allocate the Transaction Price
An entity typically allocates the transaction price to each performance obligation on the basis of the relative standalone selling prices of each distinct good or service promised in the contract. If a standalone selling price is not observable, an entity estimates it.
Step 5: Recognize Revenue
An entity recognizes revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer (which is when the customer obtains control of that good or service). The amount of revenue recognized is the amount allocated to the satisfied performance obligation. A performance obligation may be satisfied at a point in time (typically for promises to transfer goods to a customer) or over time (typically for promises to transfer services to a customer). Now that you have a basic understanding of the new revenue recognition compliance standard, it is time to determine how your business is affected. Below are some questions to help determine just that.
Is your business:
- Currently operating in one of the above 16 industries?
- Needs to have a contract in which there are multiple deliverables that you will need to perform?
- Do you have products or services that take multiple months or years to provide?
- Provide subscription-based services?
- Has a contract that provides a cancellation or opt-out clause?
- Currently operating on a non-fixed pricing model?
If you would like to learn more about the new revenue recognition reporting guidelines, please contact NOW CFO today and set up a free consultation appointment. NOW CFO can help you establish a game plan and timeline to make sure you are ready to comply with these new guidelines.
ABOUT THE AUTHOR: Jessica Howard is writer and editor for NOW CFO at the Salt Lake City corporate offices. Jessica has extensive knowledge in broadcast journalism, content marketing and public relations. She currently has multiple projects underway to increase the brand awareness for NOW CFO. Her work has been featured on various platforms, namely The Boston Herald and multiple online blogs. Jessica attended the University of Utah and obtained a Bachelor of Science degree in Mass Communications with a double minor in Journalism and Business Administration. She enjoys being a member of The National Society of the Colonial Dames of America and the American Society of Business Publication Editors.