New Revenue Recognition Standards are Here
In what is widely considered to be the largest shift accounting has seen in recent years, new revenue recognition accounting standards are set to become a reality in 2017. Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606), goes into effect for public companies in fiscal years beginning after Dec. 15, 2016, and non-public entities in fiscal years beginning after Dec. 15, 2017.
The new standard requires companies to recognize revenue when transferring goods or services to customers, in an amount to which the company expects to be entitled. The new guidance was designed to create consistency and comparability across industries.
Revenue recognition is a fundamental metric for most companies, and one on which most executives, managers and investors base their decisions. For some industries that rely on customer contracts, such as construction, the impact is evident, but the new standards will affect practically all companies that are subject to U.S. Generally Accepted Accounting Principles (GAAP). The impact may come from changes in the timing of recognizing revenue, and the significant increase in required disclosures or necessary modifications to information technology systems, processes and internal controls to capture new data and address changes in financial reporting.
Far beyond affecting just contractors, the new standards will impact technology, telecommunications, attorneys, engineering and design industries, and any organization that enters into contracts with customers to transfer goods or services. The standard will also impact companies who enter into contracts for the transfer of non-financial assets, unless those contracts are covered by other standards, such as leases and insurance contracts.
Challenges and Opportunities
Accounting for revenue has always been one of the most challenging aspects of finance and accounting, as well as one of the leading causes of restatements. Companies without a well-planned, comprehensive approach for adopting the new standard will likely have a hard time with compliance.
Many companies have found that their existing financial reporting systems have to be modified to support compliance with the new standard, but the implications reach outside the accounting department, according to an article in Strategic Finance. Often, many parts of a business are tied to revenue, so compliance with the new rule will also affect debt covenants, contracts, taxes, IT and sales departments.
While implementation is a hurdle that must be jumped, the new guidelines should benefit investors by providing clarity to revenues reported in financial statements across industries. The new standard eliminates the transaction- and industry-specific revenue recognition guidance under GAAP, replacing it with a principle-based approach.
All companies that report using U.S. GAAP are required to adapt to the new standard. Non-public companies typically have a choice of using GAAP or another reporting method. Public companies are required to use GAAP. Those that don’t adopt the new standard run the risk of additional scrutiny and forced financial statement revision from the SEC.
According to a recent PwC survey of more than 700 accounting and finance executives, 78 percent of companies have at least started to analyze the impact of the new standards, but many have not completed the assessment or taken steps toward implementation. With that in mind, here are a few suggestions for preparing for adoption:
Choose a Transition Method
Entities can opt to use either a full retrospective transition method or a modified retrospective transition method under the new standard. If substantial differences are expected between accounting for revenue under the company’s legacy revenue systems and the new standard, the company may want to consider using the full retrospective transition method. Under this approach, the company reflects revenue consistently for all years presented in its financial statements. Under the modified retrospective transition method, the new standard is applied only to the latest year presented. Whichever method is chosen, companies will need to weigh the interest of investors and stakeholders against the time and effort necessary to comply.
Consider Using Outside Resources
The PwC survey found that 63 percent of respondents plan on using internal resources to support the implementation of the new standard. Given the amount of work that will need to be done, and the fact that so many companies have not even completed impact assessments, companies may want to consider how the transition will strain internal resources and hire consultants to reduce the burden of compliance.
Anticipate Implementation Costs
The PwC survey also found that 58 percent of respondents see incremental implementation expenses in the range of $500,000. Only 10% anticipate costs rising above $1 million. Given the significant impact on systems, processes and controls, companies should begin planning and budgeting for these additional costs immediately.
With revenue being a key financial metric, all companies reporting under U.S. GAAP should expect to see some material impact on their financial statements. Changes are coming fast, and the earlier implementation issues are identified, the easier it will be to address them and alert key stakeholders about potential problems.