Landmark Revenue Recognition Standard Issued
- On May 28, 2014, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) completed work on their four-year joint project to develop a single revenue recognition model. There are potentially significant changes ahead for certain industries, and some level of change for almost all entities.
The scope of the guidance applies to revenue arising from contracts with customers, except for the following: lease contracts, insurance contracts, contractual rights and obligations within the scope of other guidance, and non-monetary exchanges between entities in the same line of business to facilitate sales to customers. In other words, the new guidance applies to 99 percent of all revenue transactions.
Currently, U.S. GAAP encompasses broad revenue recognition concepts and numerous requirements for particular industries or transactions that can result in different accounting for economically similar transactions. The core principle of the new guidance is that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration that the entity receives or expects to receive. To apply that principle, an entity should:
- Identify the contract with a customer
- Identify the separate performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the separate performance obligations
- Recognize revenue as each performance obligation is satisfiedThe new guidance could significantly change how many entities recognize revenue, especially those that currently apply industry-specific guidance. The new guidance will also result in a significant increase in the volume of disclosures related to revenue. All entities will likely have to consider changes to information technology systems, processes, and internal controls as a result of the increased disclosure requirements, among other aspects of the model. The following are some of the industries directly impacted by the new guidance:
- The five steps might appear simple but significant judgment will be needed to apply the underlying principles. Most difficult may be the change of mindset needed about revenue recognition to move from an evaluation of risk and rewards under existing guidance to an evaluation of transfer of control under the new guidance.
- Construction – recognition of contract revenue and contract costs will be decoupled; smooth margins will only result if a company determines that a cost-to-cost method most appropriately measures progress towards satisfaction of the performance obligation.
- Manufacturers – additional transactions may meet the bill-and-hold criteria as compared to current guidance, which may result in accelerated revenue. Entities that manufacture large volumes of homogeneous goods with short production cycles that are specifically designed for a customer may be required to recognize revenue using the transfer over time model (versus upon delivery of the final product to the customer).
- Intellectual property and licenses – entities will need to determine whether a distinct license arrangement represents a promise to transfer intellectual property at a point in time versus a promise to provide the customer access to the entity’s intellectual property over time.
- Sales of real estate – specific requirements for profit recognition on sales of real estate under current U.S. GAAP have been eliminated, which may result in accelerated revenue (or gains).
The impact of implementation may be felt across the entire company. Management will need to perform a comprehensive review of existing contracts, business models, company practices, accounting policies, information technology systems, and internal processes and controls to assess the extent of changes needed as a result of the new guidance. This may be the case even if the entity’s revenue recognition model is not significantly changed.
More information about this new standard can be found in Regulatory Update.
New Going Concern Standard Just Around the Corner
- The FASB has tentatively decided to require management of public and private companies to evaluate and disclose whether there is substantial doubt about a company’s ability to continue as a going concern. The assessment would be similar to the one auditors are required to make today. But unlike the auditing standards, the US GAAP guidance would define “substantial doubt” by incorporating a likelihood component and using the term “probable.”
The FASB also determined that, when making this assessment, management should consider relevant conditions or events that are known or reasonably knowable on the date the financial statements are issued (or for private companies, are available for issuance). In addition, the entity’s ability to meet its obligations would be assessed for a period of one year from that date. Under auditing standards, the assessment period is 12 months from the balance sheet date. The FASB also decided that a final standard would be effective for annual periods beginning after December 15, 2015 and interim periods thereafter, partly to give the Public Company Accounting Oversight Board (PCAOB) and the AICPA’s Auditing Standards Board (ASB) time to update their auditing standards.
Find out more about this proposal in Other Developments.
Final Standards Related to Financial Instruments Expected by Year’s End
- At its June meetings, the FASB continued to fine tune its proposals on financial instruments. Specifically, the FASB has made decisions about presentation and disclosures for financial instruments, as well as decisions related to impairment and the “current expected credit loss” model. For an update on recent decisions in Other Developments.