“The Financial Accounting Standard Board (FASB) was busy during 2016. A total of 20 accounting updates and amendments were issued, and two of the 20 are either impacting our clients now or will so in the next couple of years,” says Seán N. Kilbane, a director of Assurance at BDO USA, LLP. “If our businesses aren’t talking about the board’s changes to revenue recognition and leases, they ought to.”
Smart Business spoke with Kilbane about changes to revenue recognition and leases.
What’s important for business owners to understand about revenue recognition?
The new revenue recognition standards will take effect in 2019 for most midsize companies, and next year for publicly traded businesses. No particular industry is immune from adopting the new standard, as FASB’s goal was to offer a greater level of comparability across all industries and to minimize differences in the way in which revenue is recognized.
For many businesses, this will impact the timing and pattern of revenue recognition. For others, especially where industry specific guidance was followed, the changes could be significant and will require careful planning.
The basic premise of the new standard is to record revenue when customers obtain control over the goods and services that are provided to them, rather than when simply ‘earned.’
The new standard requires companies to identify their customer contracts, and such contracts can take many forms. After figuring out what contracts they have, businesses must assess what distinct items they have to either deliver, produce or provide services for, and for which of those distinct deliverables the customer benefits from — either if sold on their own or in a combination with other deliverables, such as construction materials together with labor for a build out of space. Businesses then determine the price of the overall contract and allocate that price to each of those distinct deliverables. Once these performance obligations are satisfied, they can recognize the revenue.
Business leaders should familiarize themselves with the new standard and evaluate the impacts on each revenue stream. They should also be aware of trickle-down effects. Businesses need to ascertain what this may mean for complying with EBITDA and other financial performance-based covenants, the income tax implications and what effects this may have on their internal control environment.
The best advice in anticipation of these changes is to act now. Businesses need to consider the various transition methods that the FASB has prescribed, look into training for finance personnel and monitor any additional updates. Their financial experts can help assist all lines of business through this transition.
How are leases changing under FASB’s updates?
This mainly impacts lessees — companies that lease property or equipment — but has less sweeping implications for lessors, such as landlords.
For small and midsize companies, beginning in 2020, lessees will be required to bring long-term leases onto their balance sheet, by recognizing the right to use the leased asset and establishing a liability to capture the present value of the future lease payments. For shorter termed leases, lessees can make a policy election to treat their leases similarly to how operating leases are currently accounted for — that is without capitalizing, and by recognizing expense evenly over the life of the lease agreement.
Each lease under the new code will need to be categorized as a financed or operating lease, depending on how much control is asserted over the asset now or will be at the end of the lease. This categorization matters, as it impacts the pattern of expense recognition and where to point cash flows in financial statements.
It’s important to be proactive, to develop a plan and consider the impacts with lenders and other stakeholders, especially since new assets and liabilities will be presented, which can significantly change a company’s financial ratios. Also, businesses should consider whether their software can handle the new complexities of lease accounting.
Again, the right advisers can help, regardless of complexity, with either an assessment of current system needs or with a new system implementation.
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