NEW GUIDANCE ISSUED
In May 2014, the FASB and the IASB issued a new revenue recognition standard, ASU 2014-09, Revenue from Contracts with Customers or ASC 606, to provide a single comprehensive accounting model for all revenue arising from customer contracts. The new standard introduces a framework to address recognition issues while removing inconsistencies and creating enhanced disclosures. The new guidance is a move away from the explicit rules-based guidance to a more principles-based approach that may lead to more diversity in practice. Calendar year end public companies must adopt the new standard on January 1, 2017, while nonpublic companies must adopt on January 1, 2018. Early adoption is not permitted under US GAAP (it is permitted under IFRS), although nonpublic companies may adopt on the public company effective date.
The core principle of the new guidance is that “an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflect the consideration … the entity expects to be entitled in exchange for those goods or services”.
NEW STANDARD OVERVIEW
The new standard introduces a five-step model for recognizing revenue where companies will:
- Identify the customer contract,
- identify performance obligations,
- determine the transaction price,
- allocate transaction price to the performance obligations, and
- recognize revenue as performance obligations are satisfied.
The new standard includes significant disclosure requirements to convey the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts.
Companies may elect either the ‘Full Retrospective’ or ‘Modified Retrospective’ method of adoption for the new guidance. Under the Full Retrospective method, companies will restate revenue under the new standard for comparative periods (i.e. public companies will restate fiscal 2015 and 2016). The Modified Retrospective method limits the application of the new standard to contracts not completed at the date of adoption. Under the Modified Retrospective application, an adjustment to retained earnings is recorded in the year of adoption to reflect the cumulative effect of adoption.
Companies should carefully evaluate the two transition methods for advantages and disadvantages. One benefit to applying the Full Retrospective adoption is the preparation of comparable revenue results to measure financial performance. A perceived benefit under the Modified Retrospective adoption is the potential for cost savings as a result of only having to analyze contracts not completed at the date of adoption. However, the disclosure requirements that are necessary for companies that choose this option will require a similar level of assessment on historical contracts and may minimize the value of this perceived benefit in the initial year of adoption.
ASSESSING THE IMPACT
Beyond the direct impact to revenue and related disclosures, the new standard could impact other aspects of the financial statements as well as the operation of the organization. Companies should prepare a complete assessment of the business to identify impacted areas, which could include the following:
- Technological capabilities to support the estimates and calculations required by the new standard
- Compliance with the companies processes and controls
- Debt covenant compliance
- Employee compensation and other incentive compensation plans based on revenue or profit metrics
- Customer contracting strategy
All companies are different and require their own assessment and implementation plan. CFGI has been working with clients using a phased approach to scope, assess, measure and ready companies for their adoption of the new standard. The first phase includes performing a diagnostic assessment to scope the impact of the new guidance on revenue streams; comparing the legacy revenue recognition guidance to the new guidance; and, depending on impact, recasting the revenue recognition for each arrangement and revenue stream identified.
TRANSITION RESOURCE GROUP (TRG)
At the October 31, 2014 TRG meeting, the FASB announced it plans to perform site visits over the coming months to assess progress made by stakeholders in the ASC 606 implementation process. The FASB plans to reach a final decision on whether to delay the effective date no later than the second quarter of 2015. Stay tuned as the TRG meets over the coming quarters.