The New Revenue Recognition Standard

By Janell Wilson, CPA - Partner
June 2019

What we keep referring to as the new revenue recognition standard isn’t so “new” anymore, as the guidance was issued in 2014. However, considering the many amendments issued in the years following and the delay of the effective date, it is still “new” to many of us.

The new revenue recognition guidance is contained in the FASB Codification, Topic 606: Revenue from Contracts with Customers. It supersedes most of the revenue recognition guidance that was in Topic 605 and other sections throughout the Codification. The guidance applies to all entities that have contracts with customers to provide goods or services. The guidance applies to all industries, but specifically excludes certain types of contracts with customers, such as lease and insurance contracts. The effective date of the revenue recognition guidance for nonpublic entities is the annual reporting period beginning after December 15, 2018. That effective date means that calendar year entities will be required to recognize the effects of the new standard in their December 31, 2019 financial statements presented in accordance with U.S. generally accepted accounting principles.

Under the previous guidance, revenue was recognized using a rules-based approach, meaning that if certain rules were met, revenue was recognized. Under the new guidance, revenue is recognized under a principles-based approach, meaning more judgement about the facts and circumstances is necessary to determine when revenue should be recognized. Four criteria must be met under the new standard for revenue to be recognized, which are as follows:

  1. There is persuasive evidence that an agreement exists;
  2. Delivery of goods or services has occurred;
  3. The price is fixed or determinable; and
  4. Collectability is reasonably assured.

The two key principles of the revenue recognition standard are (1) revenue should be recognized in a way that reflects the transfer of a promised good or service to a customer and (2) the amount of revenue recognized should equal the consideration to which the entity expects to be entitled. These two principles sound straight forward, but they may become complex if there is not a clear understanding of when a good or service is transferred, if there are multiple goods and services being provided, or if the consideration received includes a variable amount.

The revenue recognition guidance uses the following five-step approach for recognizing and measuring revenue:

Step 1: Identify Customer Contracts – A contract is simply a written or verbal agreement between two or more parties that creates enforceable rights and obligations.

Step 2: Identify Performance Obligations – A performance obligation is the promise to transfer distinct goods or services to the customer. A “distinct” good or service is one that the customer can use, consume or sell, and can be separately identified from other promises in the contract.

Step 3: Determine the Transaction Price – The transaction price is the amount that an entity expects to be entitled to for fulfilling its obligation to transfer promised goods or services to a customer. Complicating factors include variable consideration (i.e. discounts, rebates and incentives), noncash consideration (i.e. shares of stock), and the time value of money.

Step 4: Allocate the Transaction Price to the Performance Obligations – The allocation of the transaction price is based on the amount of consideration the entity expects to be entitled to in exchange for satisfying a performance obligations. The allocation is straight forward when the contract has one performance obligation, but it becomes more complex when there are multiple performance obligations. For example, an entity that agrees to sell a piece of equipment and provide maintenance must allocate the transaction price between these two distinct performance obligations.

Step 5: Recognize Revenue as Performance Obligations are Satisfied – The transaction price allocated to the performance obligation is recognized as revenue when the performance obligation is satisfied, which is when the customer gets control of the related goods or services.

Implementation of the new guidance will impact your business. The new guidance requires new financial statement presentation and enhanced disclosure requirements. It also requires retrospective adoption of the standard using one of two available methods impacting financial statement presentation. Your business should be evaluating the impact of the new revenue recognition standard and be aware that in certain circumstances, changes to operations, customer contracts and terms, internal reporting and performance measures, policies and procedures, accounting and IT systems, and internal control may be needed.

Our Accounting and Assurance professionals are here to assist with revenue recognition analysis and implementation. Please contact Janell Wilson at 847.213.2092 or your accounting and assurance partner at 847.982.0333 to discuss your specific needs.

Janell Wilson, CPA, Partner, has served as a trusted advisor to clients for over 20 years focusing on accounting and assurance for various industries within the private middle market sector. She enjoys working closely with entrepreneurs and business owners to improve accounting systems and procedures and strengthen internal controls. Her industry specializations include manufacturers, automobile dealerships, professional service providers, retailers, and leasing companies. Janell works with nonprofit organizations, including religious organizations, arts and cultural organizations, trade associations, and other public charities and private foundations. Janell also has extensive experience with employee benefit plans.