"Is your company ready for the new revenue accounting rules?"
As January 2019 rapidly approaches, many private companies are faced with the looming challenges associated with the adoption of the largest accounting change in recent memory, Financial Accounting Standards Board Accounting Standards Codification 606, Revenue from Contracts with Customers.
While ASC 606 has many benefits to the users of the financial statements, none the least of which is the elimination of complex and prescriptive rules under pre-ASC 606 generally accepted accounting principles, it also has many challenges for those tasked with adopting the new standard.
The core principle of ASC 606 -- to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration that the company expects to collect -- underscores the five steps needed to apply the standard: 1) identify the contract with a customer, 2) identify the performance obligations, 3) determine the transaction price, 4) allocate the transaction price, and 5) recognize revenue when (or as) a performance obligation is satisfied. Private companies will be tasked with reevaluating how they record their revenue -- and in many cases, will need to account for transactions differently from how they have historically. While there are many challenges associated with interpreting the new accounting, adoption may be the most daunting obstacles for compliance, as it requires an assessment of not only new contracts entered into going forward, but contracts that have been accounted for under the legacy standard.
Public companies have invested in dedicated adoption teams to identify key business processes, reevaluate current management information systems, and develop, refine and implement the necessary internal controls to comply with the new standard. While more straightforward revenue transactions should generally have straightforward accounting, there will be continued key areas of judgment.
The new standard increases the amount of information companies must disclose related to revenue, contracts and judgments, including:
• Revenue: Disaggregation of revenue and amounts recognized relating to performance in prior periods.
• Contracts: Information about contract balances, changes, and performance obligations.
• Significant Judgments: Information regarding the determination of the transaction price and amounts allocated to performance obligations.
Many private companies, which vary in size, sophistication, and resources available to commit to this effort, will find themselves in an unfamiliar position. To comply with the accounting requirements once this new standard becomes effective, companies that issue GAAP financial statements will need to take a new look -- and in many cases, a new perspective -- at their current business processes.
To the extent they have not already begun assessing the changes to their current processes, private companies will need to address many critical questions, including:
• How many of their contracts contain termination clauses? What are the terms and conditions of termination? What about contract modifications?
• How do they determine whether an entity has an enforceable right to payment?
• Do they offer any customer options? Are there any variable considerations?
• How should they determine the measure of progress when a single performance obligation contains multiple promises or activities?
• How should they recognize revenue once the applicable criteria are met if a performance obligation is only partially?
• Are these facts and circumstances determined through a manual or automated process? If manual, who makes the key determinations?
The answers to these questions are critical under ASC 606.
• Michael Fernandez is a director in FGMK's assurance practice and quality control group.