Earlier this year the Financial Accounting Standards Board (FASB), responsible for U.S. Generally Accepted Accounting Principles (US GAAP), and the International Accounting Standards Board (IASB), responsible for International Financial Reporting Standards (IFRS), issued jointly a converged standard on the recognition of revenue from contracts with customers that will supersede virtually all revenue recognition guidance currently in US GAAP and IFRS. The new standard was issued to address a number of concerns regarding the complexity and lack of consistency surrounding the accounting for revenue transactions.
As part of the efforts by the boards to converge US GAAP and IFRS, the new standard eliminates the transaction and industry specific revenue recognition guidance under current GAAP and replaces it with a principles based approach for revenue recognition. The intent is to avoid inconsistencies of accounting treatment across different industries and geographies. In addition to improving comparability of revenue recognition practices, the new guidance is intended to provide more useful information to financial statement users through enhanced disclosure requirements. While the boards actually issued two separate standards, the FASB and IASB have essentially achieved convergence with these standards, with some minor differences related to the collectability threshold, interim disclosure requirements, early application and effective date, impairment loss reversal, and nonpublic entity requirements.
The objective of the new guidance is to establish the principles for an entity to apply to report useful information to users of financial statements about the nature, timing and uncertainty of revenue and the related cash flows arising from contracts with customers.
The core principle of the new standard is for an entity to recognize revenue to depict the transfer of promised goods or services to customers in amounts that reflect the consideration to which the entity expects to be entitled in exchange for those goods or services.
The principles in the new standard will be applied using the following five steps:
1. Identify the contract(s) with a customer.
2. Identify the performance obligations in the contract.
3. Determine the transaction price.
4. Allocate the transaction price to the performance obligations in the contract.
5. Recognize revenue when (or as) the entity satisfies a performance obligation.
The guidance also specifies the accounting for some costs to obtain or fulfill a contract with a customer, as well as enhanced disclosure requirements.
An entity will need to exercise judgment when considering the terms of the contract(s) and all of the facts and circumstances, including implied contract terms. An entity also will have to apply the requirements of the new standard consistently to contracts with similar characteristics and in similar circumstances.
The guidance in the new standard affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (for example – insurance contracts or lease contracts).
The new standard must be adopted using either a full retrospective approach for all periods presented in the period of adoption (with some limited relief provided) or a modified retrospective approach.
The new standard will take effect for public entities following US GAAP for annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. For nonpublic companies following US GAAP, the new standard will take effect for annual reporting periods beginning after December 15, 2017, and interim and annual reporting periods thereafter.
The period of time from issuance until effective date of the new standard is longer than usual because of the scope of entities that will be affected and the potentially significant effect that a change in revenue recognition has on other financial statement line items.
While the prospect of preparing for the significant changes in the new revenue recognition standard can be somewhat daunting, entities should take advantage of the longer effective date and start preparing now for the transition to the new standard. As part of the transition process entities should evaluate the potential impacts on financial statements, information systems, processes and controls. An early assessment will be the key to managing implementation of the new standard. For more information, please contact your local UHY LLP professional.