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SuraLinkWritten by Derrel Curry, CPA, CGMA and Stephen Von Hagel, CPA, CGMA
As many of you are aware, in 2014, the Financial Accounting Standards Board (FASB) issued a new standard governing revenue recognition. The new guidance converges with the equivalent IFRS 15 guidance to provide a framework for companies to follow when preparing financial statements. The FASB believed that existing requirements did not provide enough data for financial statement users to glean the necessary information to be fully informed of a company’s financial position. The new guidance takes effect beginning December 15, 2017 for public companies and December 15, 2018 for all other companies. Therefore, a calendar year-end, non-public company will first apply the new standard for the year ending December 31, 2019. However, regardless of how small or how large this change affects your company, there are necessary steps that need to be taken to ensure that you have the necessary procedures and processes in place to effectively document your revenue recognition.
According to the FASB Accounting Standards Codification (ASC) 606-10-50-1, “the objective of the disclosure requirements in [the revenue standard] is for an entity to disclose sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.” The standard further indicates that “an entity shall consider the level of detail necessary to satisfy the disclosure objective and how much emphasis to place on each of the various requirements. An entity shall aggregate or disaggregate disclosures so that useful information is not obscured by either the inclusion of a large amount of insignificant detail or the aggregation of items that have substantially different characteristics (ASC 606-10-50-2).”
While this raises many questions, please keep in mind that there will be a significant amount of judgment required to determine what disclosures will be necessary. All entities will need to include relevant disclosures in order to meet the disclosure objectives put forth in the standard but need not repeat any disclosures with information that is already included for other accounting standards. The new standard is also required for any interim reporting periods in addition to the year-end reporting period requirement.
Prior to FASB 606, the old guidance provided only a broad concept with numerous requirements for specific industries which oftentimes resulted in inconsistent accounting for similar transactions. FASB 606 revises the minimum requirements to create a more consistent framework of stating revenue so that more informed decisions can be made regarding a company’s financial status.
More specifically, the standard provides guidance on the presentation of assets and liabilities that arise from contracts with customers. Companies will be required to document their contracts in financial statements as either contract assets or contract liabilities, or some similar language, depending on the terms and circumstances of the contracts. To achieve the core principle of the new guidance requires five actions:
- Identify the contract with a customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price
- Recognize revenue when or as the entity satisfies a performance obligation
Knowing these five actions will help you identify which contracts and transaction types will be impacted, determine which processes and systems will require modification, and communicate the impact to stakeholders.
When considering whether to adopt early recognition or wait until the official reporting requirement date, you will need to determine which of two methods you would like to utilize in the adoption of FASB 606: the retrospective method or the cumulative effect method (also referred to as the “modified retrospective” method).
There are four practical expedients available to ease the transition for entities using the retrospective approach. An entity can choose to use one or more of the practical expedients below.
Practical Expedients
The illustration below explains each practical expedient (PE).
| PE 1 | Completed contracts (those which begin and end within the same annual reporting period) need not be restated. |
| PE 2 | For completed contracts that have variable consideration, an entity can use the transaction price at the date the contract was completed rather than having to estimate the variable consideration amounts that existed in the comparative reporting periods. |
| PE 3 | For all reporting periods presented before the date of initial application, it is not necessary to disclose the amount of the transaction price allocated to the remaining performance obligations or disclose when that amount is expected to be recognized as revenue. |
| PE 4 | For contracts that were modified before the beginning of the earliest period presented, an entity may elect not to retrospectively restate the contract for those modifications and instead will reflect the aggregate effect of all modifications that occur before the beginning of the earliest period presented when identifying satisfied and unsatisfied performance obligations, determining the transaction price and allocating the transaction price to performance obligations. |
If the cumulative effect method is used, then only one practical expedient above is available. PE 4 may be applied for all contract modifications that occur before the beginning of the earliest financial statement period.
Whichever method you choose, you will need to include disclosures regarding your decision in your financial statements as well. For the retrospective method, you will need to include:
- The nature and reason for the change in accounting principle
- A description of the prior-period information that has been adjusted
- The effect of the change on prior-period income from continuing operations, net income and other affected line items, as well as earnings per share amounts affected. The transitional guidance provides an exemption to the requirement to disclose these effects for the current period.
- The cumulative effect of the change on retained earnings or equivalent as of the beginning of the earliest period presented
An entity that issues interim financial statements is required to present these disclosures in both the interim and annual financial statements in the year of adoption.
For the cumulative effect method, you will need to include the following information:
- Additional disclosures to help users understand the effect on trend information as comparative information will not be restated
- Whether the entity has applied this guidance to all contracts at the date of the initial application or only to contracts that are not completed at the date of the initial application
- The amount by which each financial statement line item is affected in the current year as a result of the entity applying FASB 606 rather than previous revenue guidance
- An explanation of the reasons for significant changes in those financial statement line items
An entity that issues interim financial statements is required to present these disclosures in both the interim and annual financial statements in the year of adoption.
At BMSS, we understand that the new standard may be overwhelming and you may need some clarification. Our accounting and auditing specialists are here to help you navigate your way through these changes and can help you determine the best course of action in developing a plan to incorporate the new requirements into your company strategy as you move into the new year and decide whether to apply early adoption or not. Please contact BMSS at (205) 982-5500 or visit our website at bmss.com.