The Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) approved sweeping changes to revenue and expense recognition for goods and services delivered pursuant to a contract. These standards go into effect for public companies in fiscal years beginning after December 15, 2016 and for nonpublic entities in fiscal years beginning after December 15, 2017.
The new rules task companies with:
- Identifying customers with whom they have contracts
- Defining their performance obligations under those contracts
- Determining the transaction price for each performance obligation
- Recognizing revenue and costs when the company satisfies each performance obligation
While these core principals may seem straight-forward, they present a real challenge for companies that support millions of customized customer contracts. For example, wireless carriers offer a broad spectrum of handset and service plan options to suit a variety of customer needs and preferences. Device and plan options change frequently to keep pace with the latest technology and consumer preferences. Customers frequently modify their plans to reflect changes in usage patterns, upgrade handsets, and/or adjust family members covered by their plans.
Here are just a few of the issues companies must give some thought to as they determine how they’ll implement the new rules:
- Companies must assess the facts and circumstances of each contract to ascertain the performance obligations, the milestones and time frames for satisfaction, and the associated revenues and expenses. Subsequent modifications to the contract must be evaluated to determine if they give rise to a new contract or be treated as an adjustment to the original contract.
- Discounts, rebates, refunds, credits, price concessions, incentives, bonuses, nonrefundable fees, penalties, etc. must be factored into the amount and timing of revenue recognition for goods and services. The method used to account for these elements must be applied consistently for similar types of contracts.
- Sales of equipment via installment payment plans demand careful scrutiny. Month-to-month arrangements have different payment obligations than term contracts. Discounts may be available on service plans based on their link to installment contracts, which impacts accounting treatment. Mid-contract equipment upgrades (e.g., cell phones) also merit special attention.
- “Free” goods and services offered as marketing incentives must be taken into consideration for revenue and expense recognition as the FASB and IASB deemed them items for which customers ultimately provide compensation.
- Contract acquisition costs – e.g. sales commissions – must be capitalized as an asset and amortized over the life of the contract unless the term is one year or less.
- Contract activation and fulfillment costs – e.g., direct labor and materials, management and supervision, insurance, depreciation – may also need to be capitalized and allocated over the term of the contract. Judgment will be necessary to determine which costs relate to a specific contract as well as when and how the underlying performance obligation has been satisfied.
- Capitalized contract assets and costs will be subject to impairment to the extent that the company does not reasonably believe that the associated revenue and expense streams will be recoverable. Companies will need to develop new mechanisms to render accurate estimates for these impairments.
- If a long-term contract has a significant financing component, the company must account for the time value of money.
- Finally, indirect channel sales must be evaluated carefully to determine appropriate revenue and expense recognition.
Since telecommunications and utility companies handle millions of customer contracts, the FASB and IASB will allow them to create a “portfolio” of similar contracts and apply the accounting rules to the collective. The company must reasonably believe that the end result of this treatment will not be materially different from applying the guidelines to each contract individually.
Clearly, this blog post barely scratches the surface of the sweeping accounting changes on the horizon. We hope that it provokes action given the nature of these changes and the challenges associated with compliance. Companies need to conduct an assessment as soon as possible to determine how they will implement the new accounting standards. Strong lines of communication must be established between the marketing and accounting departments to ensure that accounting stays abreast of changes in product and service contracts. Changes to their accounting policies, accounting systems, internal controls, and documentation merit careful consideration.
It’s a BIG job! Contact us for assistance.