Soon, it will be easier for users of financial statements to compare companies. But as this new revenue recognition standard comes on line, there may be some growing pains for businesses.
George Pickard, CPA, MSA, principal in the Audit and Accounting Service Department at Ciuni & Panichi, says the new revenue recognition standard is a joint project between the Financial Accounting Standards Board, that establishes financial accounting and reporting standards for entities following U.S. Generally Accepted Accounting Principles (GAAP), and the International Accounting Standards Board, which establishes such standards for entities following international financial reporting standards or IFRS.
Smart Business spoke with Pickard about the new revenue recognition standard and what business leaders need to know.
What changes under the new standard?
It gives everyone core accounting rules for recognizing revenue when they enter into contracts with customers to provide goods or services, so there’s better comparability across entities, industries, jurisdictions and capital markets. It makes it easier to analyze a company through its financial statements and provides more disclosure for users of financial statements.
Companies will use a five-step process for recognizing revenue:
1. Identify all customer contracts to provide goods or services, whether written, oral or implied by customary business practices.
2. Define the performance obligation(s) within that contract. Are there multiple steps with different deliverables?
3. Determine the transaction price.
4. Allocate the transaction price across the different performance obligations.
5. Recognize revenue as each performance obligation is satisfied.
Many companies will recognize revenue sooner; before they might have recognized revenue upon completion of the contract.
When does the new revenue recognition go into effect? Are there exemptions?
Public entities, certain not-for-profits and certain benefit plans are implementing it for the 2018 calendar year — if they have not already done so. For all other entities, it will be effective for 2019 calendar year items.
Transactions that follow other standards are exempted. Examples include lease contracts, insurance contracts, financial instruments and guarantees.
How should business leaders act?
Even private companies should look at this now. Encourage your CFO and accounting department to be proactive and ask for help. Get your system up early, so it can capture the information you’ll need for decision-making or the different disclosures. That way, you’re not rushing around or incurring higher costs than necessary. Also, this is retroactive. If your 2019 reports compare to the previous year, you’ll have to restate the 2018 numbers to comply with the new rules.
Identify all of your revenue streams and contracts to see how things might change. Your human resources and/or IT department may need to get involved. In addition, look at your loan covenants and grants to determine if any reporting obligations are tied to revenue. You don’t want to trip a covenant and then start having conversations with your bank.
Where will biggest obstacles occur?
You may need to change your systems, which could be time consuming and costly. It may not just be your accounting system, but also the system, let’s say, on your manufacturing floor.
Of the five steps, determining the transaction price will be the most difficult piece. Do you have variable consideration, such as a bonus for early completion? If so, it may need to be recognized earlier. Are you getting paid in non-cash? For items like stock, when do you recognize it and how much should it be valued at? Could there be a financing component? If you’re not going to be paid until two years down the road, is that interest income? Do you give discounts or rebates and how will those be considered?
Recognize the issues and start having conversations with your bank, your accountant and internally. You may decide to simplify your contracts. You may need to change your bonus policy if it’s tied to revenue. It will take time to adjust, so the sooner you start, the better.
Insights Accounting is brought to you by Ciuni & Panichi, Inc.