By Prathibha Lakshmanan
The new revenue recognition standard will heavily impact how most companies can classify and report revenue. This model is designed to apply to all industries so that it is easier to compare financial statements across companies. The standard takes effect in January 2019 for private businesses. Companies may need to make significant process changes to ensure they comply.
The Basics: What is Changing?
Revenue is one of the most important financial indicators of a company. Previously, Generally Accepted Accounting Principles (GAAP) used a rule-based system for companies to calculate revenue. The system failed to address certain type of arrangements, and so it was not universal for all industries.
The new revenue recognition standard is a principle-based system. Revenue will now be measured based on performance obligations, like service provided, contract terms, and entitlement. The change is expected to bring about unambiguous, consistent revenue standards.
Why it Matters
The new revenue recognition standard will require sweeping changes in how companies calculate revenue. Because the new standard is based on principles instead of rules, management will need to make more judgement calls than before. There may be a significant time investment upfront, since companies can no longer use a checklist-style model for revenue calculations.
Accounting departments will need to understand how to apply the new revenue standard to each contract type. Further, accounting departments should review how various situations like changes in contract terms or partial work completion can impact revenue.
Importantly, companies will have to assess what process changes are necessary across departments, including information technology systems, sales & marketing, and human resources.
When You Must Comply
The Revenue Recognition accounting standard update by the Financial Accounting Standards Board (FASB) was effective since 2017 for public companies. Since December 15, 2018, it is now be applicable for all private companies for quarterly and half yearly reports.
For companies following the calendar year, annual reporting should be under the new accounting standards for the year ended December 31, 2019.
Steps to Comply with Revenue Recognition Standard
The new standards apply to all contracts with customers. They do not apply to contracts like leases and financial services. Private companies should take the following steps to prepare for revenue recognition.
Step 1: Make sure that your work commitment in your contract with the customer is clear, approved, and has clearly-defined monetary value.
Step 2: Be clear on the goods or services promised in the contract.
Step 3: Determine the price of the transaction. This is the amount the company expects to receive in exchange for the promised goods or services in the contract.
Step 4: Allocate the transaction price to your performance obligation.
Step 5: Before a company can recognize revenue, control of the goods must pass to the customer or performance obligations must be met.
Companies will need to perform a deep dive of internal processes to calculate revenue according to new Revenue Recognition standards. For many companies, this is a complicated and time-consuming process. Get support on contract review and auditing the firm-wide processes your company will need to meet the new standard in 2019. Contact an experienced Chugh CPAs, LLP professional today.