The accounting for revenue recognition is one of the most important and complex challenges facing companies today. Revenue recognition has been and continues to be one of the top accounting and auditing areas of risk. Failure in internal controls over revenue recognition remains one of the most significant causes of material weakness in internal controls over financial reporting.
Many companies offer multiple solutions to their customers’ needs. Those solutions may involve the delivery or performance of multiple products, services, or rights to use assets, and performance may occur at different points in time or over different periods of time. There are many complex rules for recognizing revenue when contracts / arrangements have more than one revenue generating activity. Further, there is increasing complexity of revenue recognition for software; since many products include embedded software, this complexity can apply to a broad range of industries.
While current rules are detailed and rapidly evolving, additional major changes are on the horizon. The US Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) have jointly issued an exposure draft on revenue recognition. If adopted, these changes would significantly alter the landscape. Companies, therefore, must explore the implications of this exposure draft.
Certain industries have adapted a unique revenue model under US GAAP that has very prescriptive requirements for recognizing revenue. The objective of the FASB / IASB’s proposed model is to have one model that would apply consistently across most industries.
Some may view the proposed model as simpler, as the detailed rules that cover various transaction types are eliminated and replaced by a general principles-based model. However, the trade-off is that along with this simplification comes the need for more judgment, more disclosure, and a likely change in certain business practices that had developed around the specific detailed requirements of the current revenue recognition rules.
Impacts to companies:
Revenue is a key performance indicator for most businesses, so the new revenue guidance will likely impact many companies well beyond their financial reporting requirements. Some of the areas that may be affected by the implementation of the new standard include:
What companies should do:
Companies need sufficient time to plan and manage the impacts of adoption. A systematic approach, involving appropriate representatives from all aspects of the business, is important to ensuring a thorough assessment of the potential impacts across all functional areas and business units of a company. For starters, companies should: