Don’t Delay Implementing New Revenue Recognition Standard
If you haven’t started making changes in light of the new revenue recognition standard, it’s time to get with the program. Accounting for revenue has now become much more complex, and those who delay adopting the new rules could face serious business risks.
The new Accounting Standards Codification Section 606 standard may change the way your company records revenue and structures deals and contracts. If you don’t adopt the new rules, you will not be in compliance with Generally Accepted Accounting Principles (GAAP) and could therefore jeopardize relationships with your bank, investors and other critical stakeholders who rely on your financial statements.
ASC 606 is effective for annual reporting periods beginning after December 15, 2018, for non-public companies. (It’s a more principles-based approach that provides a single comprehensive framework for recognizing revenue.
5-step process for contracts
The new revenue recognition standard was developed in an attempt to condense numerous regulations and interpretations, and to improve the way companies account for revenue and deferred revenue.
ASC 606 outlines five key steps for customer contracts:
- Identify the contract: The first step is to identify the contract, which establishes enforceable rights and obligations with the customer. All parties must have approved the agreement and be committed to their obligations. Each party’s rights and payment terms must be identifiable, the agreement must have commercial substance, and collection must be probable.
- Identify performance objectives: Next, you need to identify all performance obligations (i.e., promises to transfer distinct goods or services to a customer) in the contract. In addition to obligations that are defined in the contract, you should consider any obligations the customer
may reasonably expect based on past experiences with your organization.
- Determine the transaction price: How much do you expect to be entitled to for transferring promised goods or services? The transaction price can be fixed, variable or both.
- Allocate the transaction price: You then need to allocate the transaction price to the performance obligations in the contract based on the stand-alone selling price of each+performance obligation.
- Recognize revenue: Finally, the allocated amounts mentioned above are recognized as revenue when or as the performance obligations are satisfied. Revenue is recognized over time if certain criteria are met. If not, revenue is recognized at a point in time.
The steps above are more complex than they may seem, and many companies have struggled with the transition. The analysis and corresponding documentation should be completed well in advance of year end reporting requirements. Addressing ASC 606 can be a complex, time-consuming endeavor for many companies and may require time and effort from both internal and external resources.
Tax implications of revenue recognition change
The new revenue recognition standard will impact taxes in addition to financial reporting. The IRS currently requires companies to file Form 3115 to request a change to certain accounting methods for recognizing revenue – for the year they adopt the new rules under GAAP. Some of the method changes are considered automatic, which means that no consent is required and that no payment is due when filing Form 3115.
Further IRS guidance is also expected around questions related to: the definition of an applicable financial statement; the taxation of changes in estimates within the applicable financial reporting framework; the treatment of advanced payments; and the taxation of amounts recognized in retained earnings. Moreover, companies that see an acceleration of income tax due as a result of revenue recognition changes may require additional planning for income tax strategies, the timing of payments from customers, and more.
As a business leader, it is your responsibility and proper corporate governance to implement the new revenue recognition standard at your company – but it’s complex. You may want to speak with your CPA to learn more about the new standard and what your company needs to do to comply by the deadline.