As published in MicroCap Review Magazine
Get Ready – the New Revenue Recognition Rules are Here
By: Corey Fischer
Managing Partner, Weinberg & Company, P.A.
January 1, 2018. Not so far away. That is the day that the new revenue recognition standard will become effective for most public companies with a calendar year end.
It seemed that this day would never come. It was long ago that the Financial Accounting Standard Board (FASB) and the International Accounting Standard Board (IASB) started their noble attempt to converge US Generally Accepted Accounting Principles (US GAAP) with IFRS, the accounting principles used by the rest of the world. While that project has pretty much derailed, the two governing bodies of accounting did agree on a new converged revenue recognition standard. Many have referred to this as one of the most major developments in accounting since Sarbanes Oxley.
So, is your company ready for this change? According to studies by the AICPA, SEC and others, many companies are not, and time is running out. If your company hasn’t already done so, it is imperative that company management begin a comprehensive study and analysis to determine if the new pronouncement affects the company’s revenue recognition and disclosure policies. The entire revenue and disclosure process will need to be reviewed and aligned with the new standard. Management will need to ensure that systems are in place to record revenue under the new principles and capture the necessary disclosures.
Currently there are numerous accounting models and industry-specific guidance for the recognition of revenue. This results in different revenue accounting for economically similar transactions. One of the goals of this new standard is to remove the highly segmented, industry-specific revenue recognition guidance that currently exists and adopt a more principles-based standard that will be applied consistently regardless of industry. The new pronouncement, Revenue from Contracts with Customers, establishes a single global standard on how companies are to recognize revenue.
The new standard provides a 5-step process to recognize revenue. This includes (1) identify the contract 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; and (5) ultimately recognize revenue when (or as) each performance obligation is satisfied.
The new standard provides guidance that isn’t in US GAAP now, including guidance on contract modifications, costs of revenue transactions, service revenue recognition, changes in estimates of contract life, transaction price, level of effort, and deliverables, loyalty programs, intellectual property, balance sheet presentation, and footnote disclosures.
For many companies, the new revenue accounting rules may not significantly affect the way revenue transactions are recorded, but could affect the financial statement disclosures. This would be true for those companies that are in a retail business, or where there is point of sale cash collection. The accounting for distribution businesses and consumer product companies should also not see too many changes, but may see certain changes in how certain costs are accounted for.
However there are certain industries and transactions where the accounting could be significantly affected. Software companies, biotech companies, entertainment companies, brand management companies and basically any company where a license or royalty is involved will be significantly affected by the new rules. Contractors, homebuilders, engineers, architects, and real estate developers that have contracts with customers are also among those that will be affected by this new guidance.
For many of these companies, the new rules may accelerate the timing of revenue recognition versus today’s GAAP guidelines. This means the new rules may allow for a sizable portion of license and other fees to be recognized upon delivery of the license to the customer. Entities that sell real estate will generally recognize revenue when control of the property is transferred, subject to the assessment of collectability, which may generally be earlier than recognition under current guidance.
In adopting the revenue standard, companies can select from two transition methods, a full retrospective method or a modified retrospective method.
Under the full retrospective method, the new revenue standard will be applied to each prior reporting period presented and the company will need to restate its 2017 financial statements in its 2018 interim and annual financial statements as if the guidance had always been in effect. For companies selecting the modified retrospective method, prior year financial statements would not be restated. Instead, companies will recognize the cumulative effect of initially applying the standard as an adjustment to opening retained earnings.
There is a lot to comprehend, and the clock is ticking. The important thing here is to ensure that Management has started its analysis because waiting for year-end will be too late.
Corey Fischer, CPA, is Firm Managing Partner of Weinberg & Company, a multi-office, PCAOB-Registered firm specializing in the audit, assurance and tax needs of micro and small cap companies. He has more than 25 years of experience, having worked with the Big 4 accounting firms, and as an SEC reporting officer for a number of NASDAQ-listed companies. He is based in Los Angeles, and is an expert in financial reporting, SEC compliance, raising debt and equity, mergers and acquisitions, and structuring accounting operations. Email: firstname.lastname@example.org or 310-601-2200.