In May 2014, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) released new guidelines for recognizing revenue in contracts with customers. It signifies the biggest accounting standard change in the last decade and will be effective for annual reporting periods beginning on or after December 15, 2018 for public companies and 2019 for private.
Today there are complex, detailed and disparate revenue recognition rules for specific transactions and industries, resulting in different industries using different accounting for similar transactions. The new standards will replace industry-specific guidelines, improving comparability across industries, within industries and throughout the global capital markets. The goal is simple – convergence & consistency across all customer contracts.
FASB: The Core Principal
Recognize revenue to depict the transfer of promised goods and services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services.
What does this mean?
Much more emphasis on the terms and conditions of a contract. Companies must consider the terms of a contract and recognize revenue when the transfer of control of promised goods or services happens, not the transfer of risk and rewards. Example: Manufacturers making large volumes of widgets produced to customer specs may be required to recognize revenue as they produce the units, in contrast to delivering them.
Planning for the move
Significant management judgement will be required, and the changes will impact the whole organization—people, policies, processes and systems. Companies must assess their current business processes, data, systems and internal controls to determine if they can capture and report the information needed to comply with the new standard. One of the most challenging aspects of the transition will be identifying and deploying the right combination of technologies and processes to manage the new requirements. Most publications suggest organizations create a Revenue Recognition Team, that includes sales, IT, operations, legal, investors and HR (if any compensation plans tied to revenue).
Industries most affected
- Telecom
- Technology
- Aerospace & defense
- Construction
- Media & entertainment
What could change under the new rules?
- Revenue forecasts
- Contracts
- Debt covenants
- Business processes
- Communications between finance and sales
- Sales interactions
- Audit frequency
- IT systems
- Compensation plans
- Internal controls
- Strategic plans
The 5 things you need to know:
- Most industry-specific guidance is out; the new approach is more reliant on professional judgement and the terms and conditions within a contract.
- Contracts will clearly have to define performance obligations and when and how a reporting entity transfers value (control of goods) to a customer.
- A single contract may contain a different number of separate performance obligations than under current U.S. GAAP. Today many technology companies treat goods and services as a single element, now they must allocate a portion of the transaction price to each obligation, at the standalone selling price.
- New constraints on variable considerations (rebates, refunds, credits and incentives). Under the new guidance, if the promised amount of consideration in the contract is variable, you must estimate the total consideration to which it is entitled and update that estimate at each reporting date.
- New rules for accounting long-term contracts. Under current GAAP, most entities recognize revenue by applying the percentage-of completion method based on reliable estimates. Under the new rules, in a long-term contract, a performance obligation will be considered satisfied only if certain criteria are met and revenue will be recognized only when control of the good is transferred to the customer.
Why is now the time to invest in a contract lifecycle management platform?
The new revenue recognition rules will require organizations to tighten up their contract management systems and processes. Today, too many organizations have an overly simplified way of managing their contracts and rely on internal processes for compliance. This leaves companies susceptible to mistakes, constrained for resources and reacting to fire-drills during audits. Furthermore, these internal processes are fragmented across teams, departments, and regions.
A Contract Lifecycle Management platform Provides:
- End-to-end contract workflow mapping and management
- Cross department transparency
- Full visibility into contract language, obligations, deliverables, and reporting
- A 360-degree view of the entire contracting process
- Corporate system integration with any Sales CRM, Financial tool, ERP, e-Signature application, Microsoft Office Suite, and more
Organizations are urged to view the adoption the same way they would a large ERP system implementation or an acquisition of another company. Scoping the project will involve reviewing the current contract request process, the revenue reporting model, the contract audit trail, and the long-term scalability of the IT systems they have in place. This will help guide implementation, creation of new workflow to mitigate risk, and a high corporate adoption rate. Now, is the perfect time for enterprise to adopt a contract lifecycle management platform.
Sources:
- FASB Accounting Standards Update, Revenue from Contracts with Customers (Topic 606)
- FASB, What is the core principal of the new standard?
- Rose Ryan, Quick Guide to Revenue Recognition. Planning your move to the new rules