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How Do Updated Revenue Recognition Standards Affect Your Business?

dollar billsNew accounting standards for revenue recognition affect multiple facets of business. Some companies have not started preparing for change and will quickly fall behind due to the tracking of data. Changes affect accounting, IT systems, legal departments, bank covenants, human resources, and more. The changes apply to all businesses and companies that use U.S. GAAP (Generally Accepted Accounting Principles) accounting standards.

The new standards are better understood when you think of them as a five-step process.

  1. Identify the Contract

After you close a deal with a new client, determine whether or not it actually counts as a contract. Here is what the new standard says:

  • A contract can be written or oral, but both parties must agree to specific goods, services, and payment.
  • A contract makes it clear who is giving and who is receiving, and identifies the rights of both sides.
  • A contract has “commercial substance.” The exchange is worth something. Collectability is probable, so most likely you will get paid.

Business IT systems are now required to track the start and end date for contracts. Human resources departments will also require extensive training to implement the new standard. Sales people, executive leadership, and those involved in investor relations should familiarize themselves with the new standard.

2. Spell Out Performance Obligations

If you determine that you do have a contract, spell out who’s doing what. According to the new standard, each performance obligation needs to be broken down into separate pieces or bundles. If the customer can use the goods or services by themselves, those items are considered distinct. If they must be used in conjunction with other items in the contract, they are not distinct. Each bundle of goods makes up one distinct performance obligation.

Legal departments will need to study the new standard and adjust contract terms to meet new standards. Management has some flexibility in identifying and grouping performance obligations. Both legal and accounting experts can provide guidance. The revenue for each bundle will each be reported separately.

3. Determine Transaction Price

The new standard introduces several considerations when determining transaction price. Discounts, rebates, refunds and royalties must be taken into account. If the customer is not paying cash, goods and services exchanged should be at fair value.

The new standard involves making estimates and judgements, then using data gathering to report. Accounting departments will be responsible for developing processes and controls to implement the standard.

4. Allocate Transaction Price

Revenue should be recognized as the business completes each distinct performance obligation. The price should reflect discounts, rebates, and sales.

5. Recognize Revenue by Performance Obligation

When the customer satisfies their obligation, the business recognizes revenue separated by each performance obligation satisfied.

The new standard changes the timing of revenue recognition. The change can affect companies when it comes to commission, bonuses, or revenue-linked compensation. Old-style systems won’t work and could create legal challenges.

The Clock is Ticking

Aspects of the new standard go into effect for periods beginning after December 15, 2017 for public entities and for periods beginning after December 15, 2018 for all other entities; however, a retrospective approach (full retrospective or modified retrospective) is required. This means that you will need to be able to track the data a year prior to the effective date. Many companies are struggling to implement changes with such wide-reaching implications. If you have questions or concerns about the new standards, discuss them with your accountant.

GJM is the largest locally owned public accounting firm in Northwest Ohio. Whether you have a small business or a huge conglomerate, contact us to find out how we can help you prepare for the change.

GJM's Mike Brough contributed this blog. Mike is a partner in the Gilmore Jasion Mahler assurance department. With over 13 years of public accounting experience, he works in a variety of industries including manufacturing & distribution, government, and nonprofit operations.