Are you prepared for the new Revenue Recognition standards?
You have heard of Revenue Recognition, and likely know you need to make changes. But WHAT? Here is what you need to know, and how it’s done.
What Businesses are impacted by the change in revenue recognition?
All businesses (across all industries) have revenue. If you prepare financial statements in accordance with GAAP (generally accepted accounting principles), it will apply to you. It also applies to program service revenue earned by non-profits.
What is Revenue Recognition?
The new revenue recognition standards will impact the amount of revenue a business records and the timing. For example, if you sell a SaaS product, you might have a customer pay upfront for an annual contract, though they receive the services on a monthly basis. Basically, you get the money before earning it.
Revenue recognition dictates that although you received this payment in one chunk, you can earn it only in pieces. You recognize the revenue as you provide the service, as you fulfill the obligations laid out in the contract. As a result, revenue recognition accounting shapes how you perceive your business’s performance and especially how you report your business’s performance.
Developed jointly by the Financial Accounting Standard’s Board (FASB) and International Accounting Standards Board (IASB), Accounting Standards Codification Topic 606 provides a framework for businesses to recognize revenue more consistently. The standard’s purpose is to eliminate variations in the way businesses across industries handle accounting for similar transactions. This lack of standardization in financial reporting has made it difficult for investors and other consumers of financial statements to compare results across industries, and even companies within the same industry.
The new standard outlines a 5 Step Process for revenue recognition for companies to follow regardless of their industry.
5 steps for revenue recognition
1. Identify the contract with a customer:
Contracts can be oral, written, or implied by customary business practices. This step outlines the criteria that must be met for an arrangement with a customer to be considered a contract.
2. Identify the separate performance obligations in the contract:
This step determines how many distinct performance obligations are included in the contract
3. Determine the transaction price:
This step outlines what must be considered when determining the transaction price, which is the amount the business expects to receive for transferring the goods and services to the customer. When you receive a fixed amount, this step is a breeze. However, it becomes more complicated when there is variable consideration involved such as discounts, rebates, refunds, credits, incentives, bonuses or penalties or price concessions.
4. Allocate the transaction price:
This step outlines guidelines for how to allocate the transaction price to the contract’s separate performance obligations.
5. Recognize revenue:
Revenue is recognized when (or as) the business satisfies each separate performance obligation. This step specifies how that should happen.
When does the new standard become effective?
For private companies with December year ends, the standard will be effective for their financial statements for the year ended December 31, 2019.
Implementing ASC 606 also has broad ramifications. The standard will impact not just your accounting and finance departments but could impact your IT systems, HR policies and more. It’s these broader implications and unknowns that have many companies concerned.
Meeting the new compliance standards will take time and careful planning. Although it may be challenging to adapt to the new standards, organizations large and small will find the transition provides an opportunity to transform their businesses for the better. Kirsch CPA Group can help you outline the challenges and solutions as you transition your organization to the new standards. Contact us at 513-858-6040.