ASU 2014-09, As Amended (ASC 606) – Revenue Recognition
In general, the revenue guidance would apply to any entity that enters into contracts with customers, excluding contracts that are within the scope of other standards. In this context:
- A “contract” is any agreement (written, verbal, or implied) between two or more parties that creates enforceable rights and obligations.
- A “customer” is a party that has contracted with an entity to obtain goods or services that are an output of the entity’s ordinary activities.
Specifically, companies should consider the following implementation advice:
1. Form a task force (or designate an individual) of accounting and operational personnel to become experts and take the lead in understanding and implementing the new revenue standard. This task force should include accounting, financial reporting, tax, sales, information technology, legal, and human resources personnel. Consider if the company’s external auditor should be part of this process.
2. Part of the task force’s required understanding is the new revenue recognition model based on ASC 606, which includes:
- Identifying the contract(s) with the customer (in writing, verbal, or based upon customary business practices)
- Identifying the performance obligations (promises) in the contract – could be one or more
- Determining the transaction price
- Allocating the transaction price to the performance obligations in the contract based on the standalone fair value of each performance obligation
- Recognizing revenue when the company satisfies a performance obligation (promise) as the customer takes control of the good or service
3. This task force should develop an understanding of the company’s current revenue streams (distinct or standalone deliverables) asking the following questions:
- Does a contract exist between the company and its customer?
- Are the goods and services exchanged/provided/settled at a point in time or over a period of time? This determines the timing of revenue recognition.
- Is there any variable consideration in the revenue stream(s) such as options to purchase or receive additional goods or services, returns and allowance policies, or incentives or penalties? This determines the amount of revenue recognition.
- Is more than one contract entered into in order to meet the promise(s) made to the customer? (Inputs vs. the promised good or service).
- What actions does the company have to take to establish that the good or service has been transferred to the customer?
- Is there any financing component for longer-term contracts (impacts the amount of revenue recognition)?
4. Take an existing revenue generating activity and walk it through the five-step revenue recognition model above. This will assist the task force in identifying what decisions must be made by the company and what accounting and other policies will need to be amended or established based on the new revenue standard.
5. Determine if the decisions made above will impact other areas of the company such as IT, legal, HR, etc. For example, incentive compensation, income taxes, debt covenants, internal controls, information systems and contract issues.
6. The task force should consider the best method of adopting the new standard for the company based on its revenue streams and user groups. The two available methods include the full retrospective approach which retrospectively changes prior period financial statements as if the new standard had always existed or the modified retrospective approach which recognizes only the cumulative effect of initially applying the new standard as an adjustment to opening retained earnings for the current period.
7. The task force should then determine if the company’s current processes and procedures, and systems and internal controls can support any changes identified.
8. Prior to implementing any changes to processes and procedures and systems and internal controls, these changes should be first tested to ensure objectives are being achieved and if any other applications are impacted by the changes.
9. The task force should also consider the impact the new revenue standard will have on key performance indicators (KPIs) at the company level and other performance/evaluation metrics for business units and individuals. Revenue is a widely-used KPI and it impacts many financial statement line items.
10. Consider the impact of the new revenue disclosure requirements and their possible impact on the accounting systems necessary to provide the information to meet the disclosure requirements.
11. The task force should document their implementation strategies and conclusions. For example:
- Create a revenue adoption memo identifying specific issues and conclusions
- Update accounting policies and procedures associated with the company’s revenue streams
- Update SOX compliance procedures including transaction flow charts and internal controls (public companies only)
- Determine policies and procedures for transaction price allocations (if any)
- Identify updated disclosure issues
- Describe needed IT changes
- Determine the budget necessary to comply with the new revenue standard
12. Implement the new standard. Some privately-held (non-public) companies currently on GAAP may want to consider if they will continue preparing and presenting their financial statements on GAAP. Alternatives to GAAP include Income Tax basis and the Financial Reporting Framework for Small and Medium-Sized Entities (FRF for SMEs). The financial reporting and disclosure impact and complexities of both the new revenue and new leasing guidance may not be needed by many privately-held companies and their users. Privately-held entities currently on GAAP should discuss GAAP alternatives with their outside accountants and practitioners and should be prepared to discuss GAAP alternatives with their clients.