Public companies have less than five months to get up to speed with a new way of reporting revenue.
On Jan. 1, ASC Topic 606, Revenue from Contracts with Customers, takes effect for publicly traded organizations, and all other companies must follow suit in 2019.
Issued by the U.S. Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) in May 2014, the standard aims to create a more comprehensive picture of revenue recognition—comparable across industries and across countries.
The key principle of the standard is that a vendor should recognize revenue to show the transfer of promised goods or services to customers in an amount that reflects consideration to which the vendor expects to be entitled in exchange for those goods or services. The timing and pattern of revenue recognition will likely change for many entities regardless of industry. In some areas, the changes will be significant and will require careful planning.
The standard will require organizations to determine revenue recognition based on five steps:
1. Identify the contract with the customer. A contract creates enforceable rights and obligations between a vendor and its customer.
2. Identify separate performance obligations. A performance obligation is a promise by a vendor to transfer goods or services to a customer. Each one is a distinct good or service from which the customer can benefit on its own.
3. Determine the transaction price.
4. Allocate the transaction price to separate performance obligations.
5. Recognize revenue as or when performance obligations are fulfilled. A vendor must assess when it fulfills each performance obligation and recognize revenue accordingly. This is based on the point at which the customer obtains control of the good or service. Outside of these five steps, the standard also includes a new disclosure objective, as well as enhanced disclosure requirements for recognizing revenue. So, while the timing and pattern of revenue recognition might not always change, new or modified internal processes might still be needed to comply with the broadened disclosure rules. The bolstered disclosure requirements aim to remedy a long-time FASB and IASB complaint: previous disclosure requirements were inadequate and often provided insufficient information for users of financial statements to understand revenue sources. This has resulted in erred key judgments made based on that inaccurate information.
The timing and pattern of revenue recognition will likely change for many entities regardless of industry. In some areas, the changes will be significant and will require careful planning.
The Securities and Exchange Commission (SEC) is also expecting companies to provide SAB 74 disclosures in their annual and quarterly reports before adopting ASC 606. The SAB 74 aims to inform stakeholders of the impact the adoption of the new revenue recognition standard could have on organizations’ financial statements. The SEC recommends that companies unsure of the impact make a statement to that effect.
According to the 2017 BDO RiskFactor Report series, which examines the risk factor sections in the latest 10-K filings of the largest 100 publicly traded U.S. companies by industry:
• 11 percent of life sciences companies cited revenue recognition as a risk to business (to be published in September).
• 7 percent of real estate investment trusts (REITs) mentioned revenue recognition as a concern.
• 12 percent of retail companies noted revenue recognition as a worry for business.
The new standard will require companies to critically review and inventory all stated and implied contractual rights, and carefully apply professional judgment. Subtle changes in contractual provisions or business practices could result in very different accounting outcomes. But with enough focused effort, consultation and coordination, having a clear, well-documented path towards ASC 606 adoption at the beginning of 2018 is achievable.
Kevin Karo is Co-Office Managing Partner of Assurance Services and Regional Managing Partner of Assurance Services for BDO.