The clock is ticking. With the January 1, 2019 deadline for the implementation of Accounting Standards Codification Topic 606 fast approaching, now is the time to act. This deadline applies to calendar year-end private companies. Issued on May 28, 2014 by the Financial Accounting Standards Board ("FASB"), Accounting Standards Update No. 2014-09, also known as the "Revenue from Contracts with Customers” Standard, affects all industries. The standard incorporates a comprehensive, five-step model aimed at removing current inconsistencies and improving comparability across entities and industries and providing more useful information to financial statement users.
Read on for the critical information you need to accurately incorporate these new standards into your private company’s reporting process.
What is the new five-step model?
This new model may be very different from your current accounting for revenue. If you are an owner or financial manager of a privately-owned calendar year-end company, you can get a head start by implementing procedures to ensure compliance. The new model outlines the following:
- Identifying the contract with the customer;
- Identifying the performance obligation in the contract;
- Determining the transaction price;
- Allocating the transaction price to performance obligations in the contract; and
- Recognizing revenue when (or as) the entity satisfies each performance obligation.
What can you do now?
Number five in the above list is especially important. An entity should recognize revenue from the transfer of 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. Revenue from a transaction or event that does not arise from a contract with a customer (whether written, oral, or implied by an entity's customary business practices) is not within the scope of the new model. As such, management must evaluate its contracts in full to identify all the relevant parties, as it is possible that portions of certain contracts are within the scope of this new guidance and portions are not, such as collaboration agreements.
One of the biggest challenges your company may face is identifying the separate performance obligations in a contract. A performance obligation is a promise in a contract with a customer to transfer a distinct good or service or a series of distinct goods or services that are substantially the same and have the same pattern of transfer to the customer.
Determining the transaction price is more nuanced, and may result in changing the timing of recognition to provide management with the ability to utilize the "probable" threshold. This will allow management to determine the expected value of the contract—including variable consideration. This variable consideration, which is to be evaluated each reporting period, includes consideration of items such as performance bonuses, penalties, refund rights and volume discounts.
We encourage all companies to determine how the new standard will impact revenue recognition. You may also want to begin incorporating changes to your customer contracts and business processes. Friedman has developed tools to assist companies with the evaluation and implementation of this new and complex accounting standard.
In addition to potential changes in accounting, there are significant new financial statement disclosures that will be required. Even if the new standard does not result in any change to the amount or timing of revenue recognized in your company’s financial statements, the enhanced disclosure requirements will pose a significant challenge. The industries which are likely to see the most change include contractors, healthcare, certain manufacturing and service sectors and software.
The 2019 deadline is steadily approaching – contact Patrick Dugan, CPA and Director at Pdugan@FriedmanLLP.com or reach out to your Friedman advisor to help your company identify and implement necessary changes.