Revenue recognition standards determine both how much and when revenue is recognized on the income statement. Any company keeping their financial statements under generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS) that enters into contracts with customers to transfer goods or services would follow the revenue recognition standards. And those standards are changing.
“Revenue is one of the most important measures used by management and investors in assessing a company’s performance,” says J.W. Wilson, CPA, director of accounting and auditing services at Clarus Partners. “So it is important to record revenue correctly and consistently.”
Smart Business spoke with Wilson about the changes to revenue recognition standards and what companies should know.
What should companies know about the new revenue recognition standards?
The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) issued new accounting standards for recognizing revenue from contracts with customers. The old rules were based on industry-specific guidance, which resulted in different industries recognizing revenue differently for similar transactions. The new guidance is industry-neutral and therefore more transparent. It should improve comparability of revenue recognition across entities and industries.
Who is affected by the change?
Any company that keeps its financial statements under GAAP or IFRS will be affected by the change to the revenue recognition standards. Companies that have not done so already should determine if the changes affect their business. This is especially vital if a company’s financial statements are given to outsiders, such as banks, regulators and investors.
The changes also affect any business that has contracts with customers to transfer goods or services. Technology sectors, such as software, engineering, construction and automotive are examples of industries that will certainly see a change.
How do the new standards affect how companies recognize revenue in contracts, in certain transactions and in financial reporting?
The new standards established the core principle 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.
One example would be software companies. The new rules will replace the current software recognition guidance under GAAP and may accelerate the timing of revenue recognition compared with today’s rules. That’s in part because under the old rules revenue was recognized once the risks and rewards of ownership transferred to the end consumer. Under the new standards, revenue is recognized when a customer obtains control of the product, even if they have a right of return or a price protection option.
When will the changes go into effect and when will companies need to implement the new reporting?
For private companies and nonprofits, the new guidance will be required for annual reporting periods beginning after Dec. 15, 2018, and interim and annual reporting periods after those reporting periods. Private companies and nonprofits may elect early application, but no earlier than the effective date for public companies.
For public companies, the new guidance will be required for annual reporting periods beginning after Dec. 15, 2017, including interim reporting periods within that reporting period. Early application is not permitted.
No business owner likes surprises. Companies should take it upon themselves to determine sooner, rather than later, whether the new standards affect their business. It not only affects their financial reporting and accounting procedures, but it also could affect other areas, such as company commission polices and how customer contracts are written.
Insights Accounting is brought to you by Clarus Partners