On May 28, 2014 the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued their final standard on revenue from contracts with customers. The standard, issued as ASU 2014-09 by the FASB and as IFRS 15 by the IASB, outlines guidance for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance.
The goals of the revenue recognition project are to clarify and converge the revenue recognition principles under U.S. GAAP and IFRSs and to develop guidance that would streamline and remove inconsistencies in revenue recognition; improve comparability; provide a more robust framework for addressing revenue issues; and increase the usefulness of the financial statement disclosures.
The core principle of the standard 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.
In order to comply with the new standard’s accounting and disclosure requirements, manufacturing, distribution and retail entities will have to gather and track information they may not have previously monitored. The systems and processes associated with such information may need to be modified to support the capture of additional data elements. To ensure the effectiveness of internal controls over financial reporting, management will need to assess whether additional controls should be implemented.
Under existing guidance, manufacturers, distributors and retailers generally recognize revenue
at a point in time, such as when a product is shipped or delivered. Under new guidance, the entity recognizes revenue when it transfers control of the good or service to the customer. The new standard specifies that an entity can recognize revenue over time if one of the following are present:
An entity that recognizes revenue over time will be required to determine an appropriate method of recognition, which may be based on cost, time, milestones or other relevant metrics.
Revenue that does not meet the criteria for over-time recognition must be recognized at a point in time. Unlike existing guidance that emphasizes an analysis based on the transfer of risks and rewards, new guidance provides multiple, evenly weighted indicators to use when evaluating if control has transferred at a point in time including:
Forms of variable consideration that are common for manufacturers, distributors and retailers include coupons, rebates, volume discounts, price protection, rights of return and price concessions. Sellers will have to estimate the variable consideration using either the most likely amount or the expected value of the consideration. Entities recognize variable consideration only to the extent that it is not probable that a significant reversal will occur, and they must update the estimate of variable consideration each reporting period.
A manufacturer, distributor or retailer is required under the new guidance to determine if it has promised to deliver more than one distinct good or service (or bundle of goods and services) in a contract. Determining the distinct performance obligations within a contract under the new guidance may be challenging to manufacturers, distributors and retailers. In some instances, services, free products, or other offerings that are currently not accounted for separately for revenue recognition may now be recognized separately based on an allocation of the transaction price.
Under the new guidance, warranty provisions must be reevaluated. Extended warranties and warranties that provide services other than assurance that a product complies with its specifications are accounted for as separate performance obligations within a contract. Offers of significant discounts, loyalty programs and other options may also be accounted for as separate performance obligations in the new guidance.
Note that these are only a few examples of changes that entities may face when implementing the new standard. Manufacturing, distribution and retail companies should evaluate all aspects of the new standard’s requirements to determine whether any other modifications may be necessary.
The standard will be effective for private companies for annual reporting periods beginning after December 15, 2018, but can be applied earlier as of annual reporting periods beginning after December 15, 2017.
When transitioning to the new revenue standard, an entity can elect to use either the “full retrospective method” or the “modified retrospective method.” With the exception of a few practical expedients, the full retrospective method requires an entity to present financial statements for all periods as if the new revenue standard had been applied to all prior periods. The modified retrospective method requires entities to apply the new revenue standard only to the current-year financial statements. Entities that apply the modified retrospective method will record a cumulative-effect adjustment to the opening balance of retained earnings in the year the new revenue standard is first applied.