Originally issued in May 2014 by the Financial Accounting Standards Board (FASB), ASC 606 Revenue from Contracts with Customers is already effective for public companies and is effective for annual reporting periods beginning after Dec. 15, 2018 for nonpublic organizations. This new standard was introduced with the intent of creating consistent revenue reporting across all businesses in varying industries and supersedes most previously effective guidance.
The new guidance was established in principle to aid in reporting useful information on financial statements about the nature, amount, timing and certainty of revenue from contracts with customers. The core principle of the new guidance is that a company should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled for those goods or services. Revenue is recognized when a company satisfies a performance obligation by transferring the promised goods or services to the customer (at which point the customer obtains control of those goods or services).
Extensive Time Needed to Review Contracts
The standard is quite extensive and the application of the new guidance could significantly affect the timing and amount of revenue recognized in an accounting period. The new standard replaces most of the industry-specific guidance and moves away from the risk-and-reward approach to a more principle-based concept that requires more management judgement and focuses on control. Companies in all industries will be affected by these changes but some, in particular, will certainly be impacted more so because of the nature of their business models, such as healthcare organizations; construction firms; manufacturers; technology providers; professional services firms; non-profits; and restaurants and franchisors. The links provided herein reference industry guides developed by Windham Brannon’s ASC 606 Revenue Research Committee.
Organizations will need to review and evaluate each of their contracts in context of the five steps under 606 below to determine the impact.
Disclosure Requirements
Disclosures represent another key area that will affect every single organization. There are additional disclosures that are required, which means companies will need to gather more information in order to fulfill the standard’s requirements even if revenue recognition is not materially impacted. Examples of disclosures include significant disaggregated revenues and qualitative information regarding the impact of economic factors; performance obligations; significant judgements; payment terms; nature of goods and services; and any obligations for refunds/returns on warranties. Developing systems to allow for the information to be gathered for these disclosures is critical.
Transition Methods, Tax Implications and Other Considerations
This expansive standard will impact other key areas such as implementation and compliance:
Transition Methods: Two transition methods are available: the full-retrospective approach or the modified-retrospective approach. Under the full-retrospective approach, all periods presented in the financial statements would be restated to present account balances and classes of transactions as if all contracts were accounted for under the new standard. Under the modified-retrospective approach, only the initial period of adoption (e.g. 2019) is presented under the new standard. The prior periods presented are unchanged and continue to be presented as they were under legacy GAAP. A cumulative effect is required to adjust retained earnings as of the beginning of the adoption period (e.g. Jan. 1, 2019) for all contracts that are uncompleted at the adoption date.
Internal Controls: Companies will need to think through their internal controls around initial adoption, ongoing contract analysis, and other changes in estimates over the contract term. It is possible that new documentation, processes, and internal controls will be required.
Technology: It is also important to think about the need for expanded or enhanced technology to capture and analyze data needed for implementation.
Legal: Additional legal expertise may be needed as it relates to the revision of contracts and the determination of whether a legally enforceable contract exists.
It is a complex process regardless of how you look at it. In order to avoid restatement of financial statements that could place companies in a negative light among their lenders when they go to raise capital, businesses need to start planning now. Windham Brannon would be a valuable resource for implementation.
If you are unsure how the new standard will specifically impact your organization and are uncertain of where to start, contact Windham Brannon’s revenue recognition specialists Cristy Walden, CPA, at [email protected] or Donna Caruso, CPA, at [email protected].
