In 2014, the Financial Accounting Standards Board (FASB) issued new revenue recognition rules for customer contracts. These new standards, known as ASC 606, are now in effect for most privately held companies and will impact 2019 financial reporting and disclosures.
As you may recall, the new rules require a five-step model of revenue recognition for contracts with customers for the transfer of goods, services, or real estate. These five steps apply to each customer contract:
1. Identify all customer contracts.
A contract is defined as having the following conditions: It identifies the rights of the parties, has payment terms and commercial value, has been approved by the parties, and payment is likely collectible.
2. Identify performance obligations.
The standard requires identification of “distinct” obligations. If the customer can use a deliverable on its own, it is considered a distinct performance obligation. If the deliverable is dependent on other pieces included in the contract, it is not considered to be distinct.
3. Determine transaction price.
If a contract includes discounts, rebates, or refunds, what are you actually going to get paid? What about other factors impacting the price, like market volatility or weather? How does the time value of money figure in if a customer pays early or late?
4. Allocate transaction price.
If the contract includes separate performance obligations, you must recognize revenue as each is complete. This means you must calculate a standalone price for each obligation. The same goes for discounts, which must be allocated against the price of each performance obligation or proportionately as revenue is recognized.
5. Recognize revenue.
You must recognize revenue as each performance obligation is completed and the control of the goods or services is transferred to the customer.
If you haven’t yet started reviewing your contracts, now is the time. Some manufacturers and distributors have already implemented the new rules, and others can learn from their experience. For example:
Document your process. Every company is different. Even companies in the same industry may arrive at different answers relative to the five steps. Be sure to document your contract evaluation process because you might need to explain it to banks, auditors, the IRS or other users of your financial statements.
Anticipate advanced income. For many companies, the new rules will result in advanced income recognition. If this is the case for your business, you will need to work with your finance and accounting team to determine the impact of the earlier timing.
Prepare for disclosures. The standard requires more significant disclosures on financial statements. What used to be explained in one or two sentences will now likely take one or two pages.
Evaluate complex contracts. If your company has master service agreements or long-term, complicated contracts, you must evaluate them as soon as possible. The process is time-consuming.
The ASC 606 standard and its related documents total more than 1,000 pages. Expect to invest a significant amount of time and effort to meet these new requirements.