Back in May 2014, the Financial Accounting Standard Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. This ASU creates a single source of principle-based revenue guidance for all entities in all industries and replaces most of the industry specific and transaction-specific guidance under current U.S. GAAP. The scope of this standard includes all contracts with customers, except lease contracts, insurance contracts, financial instruments, guarantees and non-monetary exchanges between entities in the same line of business to facilitate sales to customers. The purpose of the new joint standard is to:
The new standard provides accounting guidance for entities that enter into contracts to provide goods or services to their customers. The guidance outlines the principles an entity must apply to measure and recognize revenue and the related cash flows. The core principle is that an entity will recognize revenue at an amount that reflects the consideration to which the entity expects to be entitled in exchange for transferring goods or services to a customer. The principles in the new standard will be applied using the following five steps:
The new guidance could substantially affect a manufacturer, distributor, or retailer, especially in these areas:
While there are many similarities with legacy GAAP, the new guidance provides more definition around determining whether a warranty should be accounted for separately as a performance obligation. An entity should account for a warranty as a separate performance obligation if the customer has the option to purchase the warranty separately. An entity will account for a warranty as a cost accrual, in accordance with the guidance on product warranties in ASU Subtopic 460-10 if it is not sold separately, unless the warranty is to provide the customer with a distinct service. If part of a warranty provides customers with a service in addition to the assurance that the product complies with agreed-upon specifications, the entity should account for that part of the warranty as a performance obligation. A warranty that provides both assurance and services should be accounted for as a service if the entity is unable to distinguish the assurance portion from the service portion.
The value ascribed to warranties that are separately priced may be affected as the arrangement consideration will be allocated on a standalone selling price basis rather than at the contractual price under current guidance. As a result, the amount of revenue that is deferred for extended warranties might differ under the new standard compared to current guidance.
Variable consideration includes discounts, coupons, rebates and buy downs. The variability in the consideration could affect whether the entity is entitled to the consideration and/or the specific amount of consideration the customer will ultimately have to pay. Under the new guidance, an estimate of variable consideration that the entity expects to pay, or will most likely pay, must be included in the transaction price to the extent it is probable that its inclusion will not result in a significant reversal of cumulative revenue recognized upon resolution of the uncertainty. Under legacy GAAP, one of the criteria for the purposes of revenue recognition is whether the price or amount is fixed and determinable. Application of this principle results in recognition of most variable consideration when the related contingency is resolved. While the new guidance includes an overall constraint on the amount of variable consideration included in the transaction price, earlier recognition of variable consideration is expected to occur in many cases under the new guidance.
This barely scratches the surface of how a manufacturer, distributor or retailer could be impacted by the new standard. All entities’ revenue recognition policies will be affected by the new guidance. The degree to which the recognition and measurement of a particular entity’s revenue will be affected will vary depending on its own facts and circumstances. However, one thing is certain; the new guidance will require all entities to evaluate whether any changes are needed to their current revenue and financial reporting processes and systems to comply with the new guidance. As of right now, the official effective date for the new standard for non-public entities is fiscal years beginning after December 15, 2017. However, on April 1, 2015, the FASB voted for a one-year deferral of the effective date. This tentative decision will be exposed in an upcoming ASU with a 30-day comment period. With that said, it still is not too early to start having conversations about the evaluation process as the new guidance is very comprehensive.