After a dozen years of collaboration and controversy, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) finally have agreed on how and when companies should recognize revenue.
Considered the “crown jewels” of accounting convergence efforts, Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, and International Financial Reporting Standards 15 are expected to produce a major shift in how companies report the top lines in their income statements.
But many are unsure exactly how the changes will pan out, as the new standard ushers in a sea change and a learning curve.
Smart Business spoke with Mostafa Popal, partner of Assurance Services at Weaver, about these reporting updates.
What changes with recognizing revenue?
Companies will follow a single set principle-based approach for reporting of revenue from contracts with customers — a shift from industry-specific guidance of today. The new guidance is a five step principle-based approach with a core principle being to recognize 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.
With the new rules, for example, companies must determine the expectation of collecting payments owed to them by recording revenue only to the extent that it’s ‘probable’ they won’t have to make a significant reversal in the future. They also must adjust the transaction price to reflect the time value of money, if the timing of the agreed payments provides customers or entities a significant benefit of financing the transfer of goods or services to the customer.
In addition, detailed footnote disclosures are required to break down revenues by product lines, geographical markets, contract length, services and physical goods.
Are there exceptions to these new rules?
Exceptions include insurance contracts, leases, financial instruments, guarantees and nonmonetary exchanges between entities in the same line of business to facilitate sales. These transactions remain within the scope of existing industry-specific generally accepted accounting principles.
Who will be affected, and when?
All companies can expect some change, but certain industries will be more affected, such as engineering and construction, industrial products and manufacturing, pharmaceutical and life sciences, retail and consumer, software and technology, and telecommunications.
For public companies, the new guidance is effective for annual reporting periods beginning after Dec. 15, 2016 (including interim reporting periods). Early implementation is not allowed. Private companies have the option of taking an extra year to implement the new rules.
So, what are the first steps for companies?
Despite having more than two years before the new standard becomes effective, most companies should gear up for adoption now, especially if they choose to utilize the retrospective approach. This would require them to present not only the current year under the new standards but also prior years need to be presented as if the standard had been in effect all along.
Companies can also make a simpler transition, the cumulative approach, which would apply the standard only to the current year figures. However, companies would still have to make some adjustments to deferred numbers and include disclosures to explain lack of comparability.
The approach companies take depends on the expectations of their financial statement readers and what industry peers utilize.
In addition, companies must look at whether their infrastructure can capture the information they will need to comply with the new standards. This cost could range from minimal to significant.
Where can firms get help with the new rules?
The FASB and IASB have formed a Joint Transition Resource Group for Revenue Recognition to field questions and concerns as companies prepare to adopt the new guidance. The American Institute of CPAs has also established 16 industry task forces that are developing a new accounting guide containing helpful tips and illustrative examples for applying the new standard.
The new global standard is expected to provide a universal accounting language for revenue recognition, but it relies heavily on judgment for companies to come up with their figures, which can differ from company to company, country to country and CFO to CFO. You need to continue to work with experts for helpful hints and considerations for applying these new rules in your industry.
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