Issued in May 2014, the new revenue recognition standard, Accounting Standards Update (ASU) No. 2014-09, “Revenue From Contracts With Customers (Topic 606),” consists of three sections:
- Section A – Summary and Amendments That Create Revenue From Contracts With Customers (Topic 606) and Other Assets and Deferred Costs – Contracts With Customers (Subtopic 340-40)
- Section B – Conforming Amendments to Other Topics and Subtopics in the Codification and Status Tables
- Section C – Background Information and Basis for Conclusions
ASU 2014-09 eliminates the industry- and transaction-specific revenue recognition guidance that exists in current GAAP. The new guidance is principles-based and provides a framework for recognizing revenue that is applicable to all industries and all transactions. It is expected to increase consistency and improve comparability across industries and transaction types.
The core principle of the new guidance is to “recognize revenue to depict the transfer of promised 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.” The new guidance provides a five-step process to achieve that principle. In general, the process centers on identifying performance obligations in a contract, defining when those obligations are satisfied, and allocating the transaction price to those obligations. The principles-based guidance does not provide a lot of specificity, so companies should consider reaching out to other experts in their industry, including their peers and accounting firms, to understand how others are interpreting and applying the new guidance.
One of the challenges in applying the new standard may come from the complexity of a company’s customer agreements. Some companies will be able to group customer agreements by type to simplify the process of evaluating contracts under the new guidance, but others may need to review each customer agreement individually if pricing, performance obligations, or other terms vary for each customer. Consideration should be given to developing internal controls over financial reporting so that a complete and accurate population of revenue contracts is assessed under the new standard. Furthermore, challenges may arise depending upon how sophisticated a company’s information systems are, as existing systems may not be able to analyze pricing and performance obligations in a manner that is consistent with the nuances of the new standard.
The FASB/IASB (International Accounting Standards Board) Joint Transition Resource Group (TRG) for Revenue Recognition has addressed a number of implementation issues. Recordings of the TRG meetings are publicly available on the TRG’s Meetings page. As a result of the TRG’s work and other stakeholder feedback, the FASB has issued four additional ASUs to clarify the revenue recognition guidance:
- ASU 2016-08, for principal versus agent considerations, affects gross versus net revenue reporting on the face of the income statement.
- ASU 2016-10, for identifying performance obligations and licensing arrangements, says that an entity does not have to identify performance obligations involving goods and services that are immaterial. It also provides guidance for accounting for shipping and handling activities and guidance for evaluating the criterion of “separately identifiable.” In addition, the ASU clarifies the licensing implementation guidance and the scope for a sales-based or usage-based royalty promised in exchange for an intellectual property license.
- ASU 2016-12, for narrow-scope improvements and practical expedients, addresses implementation issues related to the collectibility criterion in ASU 2014-09, an accounting policy election for the presentation of sales taxes, noncash consideration, contract modifications at transition, and completed contracts at transition. Also, related to transition, this update provides a technical correction: An entity that retrospectively applies the new revenue recognition standard to each prior reporting period is required to disclose only the effect of the changes on any prior periods retrospectively adjusted and not the effect for the period of adoption. Without this change, transition costs would have been significantly increased as contracts would have to be accounted for under former GAAP and Topic 606 for one additional year.
- ASU 2016-11, to rescind the SEC guidance on revenue recognition because of ASU 2014-09, pursuant to staff announcements at the March 3, 2016, EITF meeting, relates to freight services in process, shipping and handling fees, consideration given by a vendor to a customer, and certain oil and gas extractive activities.
The FASB also has two technical corrections and improvement proposals in the pipeline related to the new revenue recognition guidance as follows:
- Proposed on May 18, 2016, the exposure draft “Technical Corrections and Improvements to Update 2014-09, Revenue From Contracts With Customers (Topic 606)” would address narrow aspects of ASU 2014-09. Nine issues are addressed by the proposal. Comments were due July 2, 2016.
- Proposed on Sept. 19, 2016, the exposure draft “Technical Corrections and Improvements to Update No. 2014-09, Revenue From Contracts With Customers (Topic 606) – Additional Corrections” addresses four additional issues brought to the board’s attention. The issues relate to guarantee fees, two illustrative examples, and advertising costs. Comments were due Oct. 4, 2016.
- The Center for Audit Quality released a tool for audit committees to use in assessing the status of their companies’ implementation of the new revenue recognition standard. The tool contains recommended questions to be asked of management along with a list of additional resources.
- On Sept. 15, 2016, the FASB hosted a presentation, “In Focus: Implementation Update on Revenue From Contracts With Customers,” which was archived and posted to the FASB’s website.
- The American Institute of CPAs (AICPA) also is helping with implementation of the revenue recognition standard. The AICPA’s 16 industry task forces are evaluating the standard’s impact with the goal of providing application observations for each industry. Draft implementation issues are posted to the Revenue Recognition page at the AICPA Financial Reporting Center.
- When transitioning to the new revenue standard, SEC registrants should refer to Topic 11 of the SEC’s Division of Corporation Finance’s Financial Reporting Manual for question-and-answer guidance on the SEC reporting requirements. The selected financial data table and financial statements of other entities are among the topics addressed.
Effective Dates and Transition
- Public business entities (PBEs) – Annual reporting periods beginning after Dec. 15, 2017, including interim periods in those annual periods. Earlier application is permitted only as of annual reporting periods beginning after Dec. 15, 2016, including interim periods in those annual periods.
- Not-for-profit entities that have issued, or are conduit bond obligors for, securities that are traded, listed, or quoted on an exchange or an over-the-counter market and employee benefit plans that file or furnish financial statements with or to the SEC – same as PBEs.
- Other entities not included in the previously identified categories – annual reporting periods beginning after Dec. 15, 2018, and interim periods in annual reporting periods beginning after Dec. 15, 2019. Early application is permitted in either of the following situations:
- Annual reporting periods beginning after Dec. 15, 2016, and interim periods in those annual periods
- Annual reporting periods beginning after Dec. 15, 2016, and interim periods in annual reporting periods beginning one year after the annual period in which an entity first applies the guidance
Transition is allowed with the selection of one of two methods:
- Retrospective application to each prior reporting period presented, and an election of any of the following practical expedients:
- Completed contracts that begin and end within the same annual reporting period do not need to be restated.
- When variable consideration is included in completed contracts, the transaction price at the contract completion date may be used to record revenue rather than estimating variable consideration amounts in the comparative reporting periods.
- In reporting periods prior to the date of initial application, disclosure may be omitted for the amount of the transaction price allocated to remaining performance obligations and an explanation of when the entity expects to recognize that remaining revenue.
- Retrospective application with a cumulative effect adjustment to the opening retained earnings balance. Under this method, an entity must disclose the following in the interim and annual reporting periods that include the initial application:
- The quantitative impact in the current reporting period, by financial statement line item, of the application of the new revenue recognition standard as compared to prior GAAP
- An explanation of the reasons for significant changes
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