Implementing the New Revenue Recognition Standard
In May 2014, the FASB issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). The new standard for recognizing revenue goes into effect for non-public entities for annual reporting periods beginning on or after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019.
Our previous article summarized the five-step model of the new revenue recognition standard and provided a number of additional considerations. The following is a summary of implementation considerations that should help with continued implementation efforts of ASC 606.
Where do I begin?
The new revenue recognition standard will impact all business entities. At a minimum, it will require a formal assessment of the new standard as well as a significant number of additional financial disclosures. We recommend the following steps to effectively adopt and implement the new revenue standard.
Educate yourself and your team on the new revenue recognition standard. We recommend assigning an individual or team of individuals to become resident experts with regards to the new standard. Your internal experts can then educate those impacted within the business.
Many companies currently believe the new standard will not impact them because they do not have contracts with customers or because they recognize revenue at the point of sale. However, it is important to understand that this standard will apply to all businesses that recognize revenue from customers. A contract by definition is an agreement between two or more parties that creates an enforceable right and obligation, whether verbal or written, and can be as simple as a standard purchase order. Some believe that because the ultimate recognition will be the same under the new standard, implementation is not required. This is also misleading, as the standard will require full implementation efforts even if there is no change in the amount of revenue recognized. This will require walking transactions through the five-step model and drafting the appropriate financial reporting disclosures.
ASC 606 is a standards change that effectively replaces the current revenue recognition standard across all industries and will affect all business entities. The change is significant, and your Aldrich team is here to make sure your adoption and implementation are as efficient as possible.
Once you are up to speed on the new revenue recognition standard, it’s time to evaluate the impact on your business. While the standard may seem to be confined to the accounting department, several interested parties need to be included in the initial and ongoing assessment. We recommend developing a plan, involving many, and then paring back as needed. Considerations for a cross-functional team:
- Adjustments to the financial statements may affect lending covenants and should be brought to the attention of the chief financial officer as soon as possible.
- The contracts department may choose to alter its standard practices should it provide a more attractive stance regarding revenue recognition or lessen accounting’s administrative load.
- Sales commissions and incentive-based management bonus pay frequently tie to revenue. These plans may need to be adjusted.
- The current accounting system may not provide sufficient flexibility to accommodate the new reporting requirements. The IT department should be engaged if a change is necessary.
- Tax accountants will need to adjust the company’s book-to-tax calculations and deferred tax liabilities based on anticipated changes to the annual filings.
- The company may need to educate current and prospective investors on this adjustment should the change evoke concern about the company’s growth trajectory or overall health.
When evaluating the impact on your business, we recommend taking a project-management approach. Develop a budget and timeline for execution, and track your progress on an ongoing basis. Document your process for contract review, and consult with your Aldrich team early and often. We recommend taking an inventory of all open and future contracts, group the similar or like contracts together, and evaluate a sample of contracts from each group. Walk each contract through the five-step model, and evaluate the change from current reporting standards. The most significant change is the accounting for variable consideration (basically anything that changes the initial transaction price), which requires a considerable amount of judgment so, if you haven’t already started your evaluation, we recommend starting now.
You also need to consider if you will adopt a full retrospective or modified retrospective approach, which allocates all prior period adjustments to January 1, 2019, retained earnings.
Now that you are familiar with the new standard and have evaluated the potential impact on your business, it is time to execute. Identify your method of adoption, and consider all periods impacted and information required to implement efficiently and effectively. If there are internal processes improvements or contract modifications that need to be made, this is the time to do it. Collecting and converting data can take a considerable amount of time so why wait? If you haven’t already, start your evaluation now and get ahead of the changes.
Your Aldrich team can work with you to help kick-start your efforts using templates that align with the five-step model as well as providing guidance for your specific industry.
A final message from early adopters suggests that the disclosure burden in the annual report was larger than anticipated. It’s a risk factor that could delay publication of the audited financial statements. As such, we recommend you draft your disclosures early so that you’ll know what numbers you need to collect.
This process will require a systematic approach, and it cannot be effectively performed at the last minute, so discuss with your team and professionals at the earliest opportunity.