The Financial Accounting Standards Board (FASB) recently amended the rules for revenue recognition in the Accounting Standards Codification (ASC) to add ASC 606: Revenue from Contracts with Customers. This addition will replace ASC 605: Revenue Recognition as well as most industry specific guidance. The implementation of this new standard will affect operations and financial reporting for almost all entities that enter into contracts with their customers, making it one of the most profound ASC amendments. This blog will explore the who, what, where, when, and why of ASC 606.
ASC 606 affects all entities that have adopted accounting principles generally accepted in the United States of America (GAAP) and enter into contracts with customers to transfer goods, services, or non-financial assets. It will not cover contracts with customers that are already covered in other topics, such as lease and insurance contracts.
In conjunction with these changes, the International Accounting Standards Board (IASB) has updated its International Financial Reporting Standards (IFRS) to include IFRS 15: Revenue from Contracts with Customers, which provides a similar framework as ASC 606. As such, the new standard will have a global impact across industries.
ASC 606 focuses on the transfer of control rather than the satisfaction of obligations prescribed by ASC 605. It’s a principles-based framework that introduces more judgement into the revenue recognition process. Its core principles are focused on the nature of the promises in a contract.
The underlying principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that they expect to be entitled to in the exchange for goods and services provided. A five step process has been designed for individual or pools of contracts to keep financial statement preparers focused on this principle. The steps include:
While this process may seem straightforward, there are many detailed considerations that need to be made for each step.
ASC 606 requires more comprehensive and detailed disclosures than what is currently required under ASC 605. The new disclosure requirements aim to provide information that will make it easier for financial statements users to understand the nature, amount, timing, and uncertainty of revenue and cash flows. Entities will be required to disclose quantitative information, including:
Qualitative information should also be disclosed, including performance obligation information, significant judgements made to determine performance obligations and transaction price, and assumptions made to determine and allocate transaction price. Additionally, information related to assets recognized from costs paid to obtain or fulfill a contract must be disclosed. These required disclosures are more robust than what is required under ASC 605, and will likely take time, effort, and possibly even require the implementation of new systems in order to be compliant.
Where and When
For public entities, the adoption of the new standard is required for fiscal years beginning after December 15, 2017, including interim periods in the year of adoption. Non-public entities have until fiscal years beginning after December 15, 2018 and interim periods within fiscal years beginning after December 15, 2019 to adopt this standard. Both public and non-public entities may elect to early adopt the standard in fiscal years beginning after December 15, 2016.
FASB has added this new standard for a few major reasons. First of all, there have always been significant differences between GAAP and IFRS in regards to revenue recognition and disclosure requirements. As the worldwide economy is becoming more interconnected, the governing boards of FASB and IASB decided to work together on a new standard that would improve the quality of revenue recognition guidance and allow for better financial statement comparability on a global landscape.
Additionally, ASC 605 is comprised of broad revenue recognition concepts along with numerous industry specific revenue recognition and disclosure requirements. This could result in different accounting treatments for economically similar transactions.
FASB and IASB’s goals for this new frameworks and standards include:
This standard overhaul will have varying impacts on different entities’ revenue recognition, depending on how they currently recognize revenue.
For further questions on ASC 606, please contact Andrew Newton at email@example.com or 240.364.2633.
In order to fully appreciate the implications of the new revenue standards it is helpful to understand the process which led to the changes.
Over the past decade, the Financial Accounting Standards Board (FASB), which establishes generally accepted accounting principles in the United States of America (US GAAP), and the International Accounting Standards Board (IASB), which establishes generally accepted accounting principles for over 100 adopting countries (International Financial Reporting Standards or IFRS), embarked on a joint project to develop criteria for revenue recognition and reporting that would accomplish key goals, including, but not limited to:
While the final standards issued by the FASB and the IASB were not fully converged, many of the major principles in the standards are now more closely aligned than they were under legacy US GAAP and IFRS. Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, and related subsequent amendments (collectively, the new revenue standards) provide guidance on both how revenue should be recognized by organizations and disclosed to stakeholders in financial statement footnotes.
How will revenue recognition diverge from current guidance under the new standards?
Under the new five-step approach required by ASU 2014-09, focus is placed on gaining a holistic understanding of contract elements and terms and disclosing this information to financial statement users.
When contracts include variable consideration or provide the customer with both a good and a service, an entity’s evaluation of how and when consideration is earned will require careful assessment. Currently, contracts are often tracked at the contract level, once the new standards are in place, tracking may be necessary at either a disaggregated level that corresponds to identified performance obligations and associated transaction prices in the contract, or at an aggregate level with other contracts. Furthermore, contracts that include warranty provisions or options to purchase additional physical goods or services will need to be analyzed to identify potentially distinct performance obligations.
While contracts receive considerable focus under the new standards, substance will continue to take priority over form, as the FASB did not want entities to manipulate contracts in order to achieve preferred accounting conclusions. With that said, contract pricing may begin to shift as the new standards are implemented, in order to facilitate alignment of the point at which customers are billed and the point at which revenue is recognized.
How will industry-specific situations be treated under the new standards, now that prior guidance is being replaced by principles-driven fundamentals? Where can my entity find additional information?
The shift away from detailed, proscriptive industry guidance has left many in positions of financial reporting responsibility wondering how they can best comply with the new standards, while also remaining aligned with industry practice.
While the FASB and the IASB worked to provide guidance with applicability across industries, as soon as the finalized core standard was issued, 16 revenue recognition task forces were established by the AICPA to address potential industry-specific issues that were either not addressed or ambiguous in the capstone guidance. The industries involved in the project include aerospace and defense, construction contractors, hospitality, not-for-profits, software, and telecommunications, among others.
Industry-specific questions have been identified by the task forces which are then reviewed by the AICPA’s Revenue Recognition Working Group (RRWG) and Financial Reporting Executive Committee (FinREC), as well as the FASB’s Transition Resource Group (TRG), where applicable. More information regarding the revenue recognition implementation issues that these groups have identified and discussed is posted regularly on the AICPA Revenue Recognition Resource Center and the FASB Revenue from Contracts with Customers Project Update.
Coming up next
The next post in this ongoing series will highlight allowable transition methods, elements of the standards that should be considered in current contract negotiations, and critical actions that should be taken immediately. In the following months, we will explore the five key elements of the new revenue recognition criteria in more detail.
For further information on the revenue recognition standards or questions on how your organization can transition to the new standards, contact Rachel Plumley at 301.231.6200 or firstname.lastname@example.org, or Philip Steigner at 301.231.6200 or email@example.com. Stay tuned for future posts.
The Financial Accounting Standards Board (FASB) has amended the Accounting Standards Codification (ASC) Topic 350 related to the subsequent measurement of goodwill via Accounting Standards Update (ASU) 2017-04. Under the ASU, companies will no longer perform Step 2 of the goodwill impairment analysis. Instead, the entity or reporting unit will compare the fair value of the entity or reporting unit to its carrying amount just like in Step 1. The impairment charge, if any, is simply the lesser of (i) the difference between the fair value of the reporting unit and the carrying amount, or (ii) the remaining carrying amount of goodwill. The entity or reporting unit still has the option of performing a qualitative analysis to determine whether or not a quantitative test is needed (i.e. Step 0).
Although different filing entities have different dates after which they must adopt the new procedures, early adoption is permitted for all entities, including public business entities, for testing dates after January 1, 2017.
Companies and their stakeholders have pushed for many years to simplify the standards related to business combinations and subsequent measurement of goodwill due to concerns over complexity and cost. In response, FASB first introduced the alternative Private Company Council (PCC) Standards in 2014 for private companies, which reduced some of the complexity related to post-acquisition accounting and purchase price allocations. Furthermore, this should significantly reduce the cost and complexity of performing a goodwill impairment analysis for public and private companies that are not adopting the PCC alternative.
Aronson LLC’s Financial Advisory Services practice assists clients in a variety of industries with numerous M&A-related activities, including pre-acquisition due diligence and post-acquisition purchase price allocation analyses, and impairment testing. For information about how Aronson can provide assistance in these areas, please contact Jimmy Zhou at 240.364.2698.
No matter if you are a small, medium or a large business, by now you’ve heard the most important reportable item on your financial statement is about to change. What you should be asking yourself however is: are you ready for it?
In September 2016, the Financial Accounting Standards Board (FASB) warned companies that many will need to accelerate their preparation in order to be ready by the revenue standard’s effective date. The new standard replaces approximately 120 elements of industry-specific guidance in current U.S. GAAP with a more principles-driven approach to revenue recognition, and thus implementation may become an extensive project.
Published in May 2014 as FASB Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, with related additional ASUs subsequently providing guidance on narrower elements, the standards collectively are the result of more than a decade of debate about how businesses and groups should report revenue. The standards offer core principles to determine how and when to record revenue, unlike the rules-based guidance U.S.-based entities are accustomed to applying.
Why is revenue the most important measure?
All users of financial statements (including management, shareholders, lenders, analysts, investors, and regulators) look to revenue as a performance and health measure of a company. Because revenue is reported as a cumulative amount of a certain period of time, trends and comparisons are analyzed as well as revenue being an important input in key financial ratios. Revenue can be the attraction or diversion to a company’s ability to attract investors, borrow money, calculate compensation and benefits, and even in tax planning.
Check back with us as we provide a series of updates and guidance to help you prepare now and in the future.
This is the first in a series of publications designed to provide assistance with implementing and understanding FASB’s new standard on revenue recognition. We are excited to give you a more in-depth view into how the changes will impact the measurement and disclosure of what is considered the most important measure of a company’s performance. Over the following months, we hope you will follow along and join us in looking at this new standard. We will provide you with what you need to know to determine the best strategies for successful adoption of the standard, as well as a practical approach to updating your policies and procedures to achieve convergence.
Under the new guidance, a lessee will be required to recognize assets and liabilities for leases with lease terms of more than 12 months. Consistent with current Generally Accepted Accounting Principles (GAAP), the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. However, unlike current GAAP—which requires only capital leases to be recognized on the balance sheet—the new ASU will require both types of leases to be recognized on the balance sheet.
The amendments in this Update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, for any of the following:
For all other entities, the amendments in this Update are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020.
Early application of the amendments in this Update is permitted for all entities.
For more information on this new standard, please refer to this press release. If you’re interested in better understanding how this new standard might impact your organization, please contact David Semendinger, Lead Partner, Quality Control Services Group, at 301.231.6200.