REVENUE RECOGNITION: It's Here. Now What?

• Author: Rix, Nancy

It took more than 11 years for the Financial Accounting Standards Board and the International Accounting Standards Board to develop a converged standard for revenue recognition, which first appeared on the boards' technical agendas in 2002. Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (ASC Topic 606) was issued on May 28, 2014.

And by now, you've likely read about the new, five-step process and know that the standard soon will be effective. You've also likely heard the warnings of the "many implications," "changing business model" or "full transformation" that will be required to be compliant. Much of this is true and, as such, it's time to start considering how this is going to impact the small-firm practitioner--including the impact of the principles nature of this standard, the transition methods and what the new standard will mean for certain industries.

Principles-based Approach

While the idea of a principles-based approach to U.S. standard setting is not new, ASC Topic 606 may be the most striking and significant example to date of the FASB's willingness to promulgate new guidelines using this approach, rather than the rules-based method. The FASB has used its conceptual framework a principles-based methodology--for more than 30 years in developing new accounting standards, but beginning in the early to mid 2000s, critics began asserting that standards were becoming increasingly detailed and rules-based, complex, difficult and costly to apply. Examples of financial engineering to structure transactions around the rules began to emerge.

Under a principles-based approach, new standards are applied more broadly and are more general, providing few bright lines and mandates. In theory, standard-setting bodies such as the FASB provide less interpretive and implementation guidance, which requires firms to prepare analyses and make extensive and critical judgments regarding measurement, recognition and disclosure issues. The FASB has commented that any guidance issued should focus "only on significant matters addressed in the standards, thereby increasing the need to apply professional judgment in the situations not addressed."

Now that we understand that applying the standard will involve significant judgment, with possibly a few specific prescriptions, let's review the five-step process.

1. Determine Whether You Have a Contract

   To determine if there is an actual contract, consider if the agreement:

   * Is approved and the parties have committed either orally or in writing;

   * Identifies the rights and responsibilities of the parties;

   * Has payment terms, though it's sufficient that if the specific amount is not included in the contracts it can easily be estimated;

   * Has commercial substance; and

   * Collectability is probable.

   Using these factors to determine whether a contract exists will be a threshold issue. There is no need to apply this standard where there is no contract.

2. Identify the Performance Obligations

   Now that you have a contract, it's time to identify what the standard refers to as the "performance obligation."

   Under the new standard, you'll need to separate each performance obligation into distinct pieces or bundles. If a customer can use or benefit from an individual good or service on its own, or with other readily available resources, that specific performance obligation is considered distinct. However, if a good or service is dependent on, or highly interrelated with, other items promised in the contract, that piece alone cannot be considered distinct.

3. Determine the Transaction Price

   The new standard provides several considerations when determining transaction price:

   * Variable consideration: Estimate what you will receive in exchange for the goods or services provided, taking into account such factors as discounts, rebates, refunds and other similar items. Historical and forecast data should also be considered when estimating consideration.

   * Constraining estimates of variable consideration: Consider constraining events when estimating the amount of variable consideration that should be included in the transaction price. Even things outside of the entity's control should be included. After each reporting period, the estimate should be updated based on the most relevant facts. Constraining events might include situations giving rise to a reversal of revenue such as a history of unsuccessful projects with a particular customer.

   * Significant financing component: A time value of money impact should be accounted for in the estimate.

   * Noncash consideration: If the customer is not paying cash for the goods or services provided, the goods or services should be measured at fair value.

   * Consideration payable to a customer: Revenue recognized should be reduced by that amount.

4. Allocate the Transaction Price

   If the contract includes separate performance obligations, revenue should be recognized as each is completed. You also must consider discounts. If a discount relates to only one or a few (but not all) specific contract items, then the discount should be allocated to reduce the transaction price of that performance obligation and reduce revenue related to that performance obligation. However, a general discount should be allocated proportionately as revenue is recognized. A similar rule should be followed for variable consideration.

5. Recognize Revenue When (or as) Performance Obligations Are Satisfied

   Under ASC Topic 606, revenue is recognized when transfer of control occurs. If the entity transfers control of a good or service over time, then revenue...