Revenue Recognition Standard
Revenue is critically important in the financial statements of companies. Thus, revenue recognition remains a priority for regulators and the accounting profession as a whole. Implementing the new revenue recognition standard, Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 606, will likely be the most significant and comprehensive change in many years for most companies.
The core principle of FASB ASC 606 is that 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. FASB ASC applies when an entity enters into a contract with a customer to transfer goods or services or enters into contracts for the transfer of nonfinancial assets. Unless the contract falls within the scope of other standards such as insurance, lease contracts or guarantees, the new guidance will apply.
The new standard involves a five-step process that includes the following:
- Step 1: Identify contracts
- Step 2: Identify performance obligations (“PO”)
- Step 3: Determine transaction price
- Step 4: Allocate transaction price
- Step 5: Recognize revenue when PO is satisfied
The most significant change from the current revenue recognition guidance is that the new standard focuses on satisfying performance obligations rather than recognizing revenue as it is earned and realized (current guidance). The effective dates of the standard (updated by Accounting Standards Update 2015-14) are for annual reporting periods beginning after December 15, 2018, not including interim periods (i.e., fiscal year 2019-20). There is transition guidance in the final standard if an entity chooses not to use full retrospective application, and the transition relief method will need to be disclosed in the company’s financials.
While the effective date seems to be a long way off (especially for private companies), there could be much work to do in the meantime. To plan for the transition, the following list offers suggestions on what companies should be doing now:
- Develop an implementation plan.
- Address areas where management judgment is necessary.
- Evaluate accounting changes and impact.
- Determine transition method.
- Request legal assistance for “enforceable contracts.”
- Review compensation arrangements.
- Consider potential IT system changes.
- Create training strategies.
The AICPA Audit & Accounting Guide has a chapter specifically for revenue recognition for Aerospace and Defense entities (chapter 3) and is a great reference that includes many examples.