6 minute read

Are You Ready for the New Revenue

Recognition Standard?
LIZ FARR, CPA

Have your clients started work on implementing the new revenue recognition
standard, ASC 606? If they haven’t, they’re not alone. A study
by MorganFranklin of accounting and finance leaders at nearly 70 emerging
and middle-market U.S. companies found that only 9 percent had completed
implementation of this new standard; 72 percent had not yet made significant
progress.

This new standard, which Accounting Today called “the biggest change to
accounting standards in the last 100 years” was issued jointly by FASB as ASC
606 and by the IASB as IFRS 15 in 2014. For public companies, this standard is
in effect for periods beginning after Jan. 1, 2018, while private companies have
an extra year.

Legacy GAAP guidance for revenue recognition was developed on an ad hoc,

industry by industry basis with specific guidance for many industries, such as
construction, real estate, software and franchises. ASC 606 applies to all types
of businesses and all types of customer contracts with the exceptions of leases,
insurance, guarantees and some non-monetary exchanges, for which separate
guidance exists.

For many businesses, such as retailers, there will be little difference other than
additional disclosures in their financials, but for others, this is a whole new
world. Companies offering subscription-type services, and provide a
combination of physical goods and services, will need to carefully consider the
agreements they have with customers now and in the future.

ASC 606 introduces a five-step process for recognizing revenue. Let’s look at
those five steps.

Step 1: Identify the contract. Under legacy GAAP, a signed contract was the
typical evidence of a contract, but under ASC 606, all that’s needed is the
existence of enforceable rights and obligations. A contract exists if there is a
transaction (a) for a business purpose, (b) with approvals and commitments in
place, (c) with identifiable rights for each party, (d) which has payment terms
identified, and (e) for which collection of the full fee is likely to occur.

Step 2: Separate the performance obligations. The components of the

transaction are identified and separated if appropriate. Components are
separated if the company also sells those components as stand-alone items or
if they have value to the buyer on their own. For example, a contract for the sale
of a piece of complex equipment that includes installation and setup may be just
one component if installation is performed exclusively by the seller, and the
equipment is useless without this service.

Step 3: Determine the transaction price. The transaction price includes all
fixed cash payments to be received by the seller and the estimated fair value of
any noncash consideration promised by the customer. If the transaction
includes future bonuses, penalties or rebates whose value is uncertain,
estimates of those amounts must be included. The transaction price also
includes benefits to the buyer or to the seller when there is a significant
financing component, which may be in the form of advance or deferred
payments. These provisions may result in sellers recognizing revenue earlier
than under legacy GAAP.

Step 4: Allocate transaction price. If the transaction includes separate

components identified in Step 2, the price must be allocated across these
components. ASC 606 provides several methods for doing this. The simplest is
based on the prices for the components when sold separately. Another method
starts with the seller’s expected costs for the components and adds a profit
margin.

Step 5: Recognize revenue. As the performance obligations are met, revenue

is recognized. Under legacy GAAP, revenue recognition focused on the transfer
of the risks and rewards of owning the goods or services and required
consideration of whether revenue had been earned and was realized or
realizable. The new model focuses on the transfer of control of the goods or
services. Recognition may be over time or at a single point in time, depending
on the nature of the goods or services and the terms of the transaction. The
standard provides several tests for determining whether the transfer is over time
or at a single point in time, which I discuss here.

Don’t underestimate the time it will take to help your clients implement this new
standard! A great overview of the new standard and those five steps is in
this white paper by RSM, and the AICPA has published an audit and accounting
guideto get you started.

FASB GAAP IFRS

About the Author

Liz has worked in tax and accounting since 2002. Besides

focusing on tax returns of all flavors, she’s worked on audits of
governmental entities and not-for-profits, business valuations,
and litigation support. Liz is also a freelance writer specializing
in content marketing for accountants and bookkeepers around
the world.

Liz Farr, CPA @liz_farr http://farrcommunications.com/