Revenue Recognition Issues
The FASB and IASB issued their converged standard on revenue recognition in May 2014. The standard provides a comprehensive, industry-neutral revenue recognition model intended to increase financial statement comparability across companies and industries and significantly reduce the complexity inherent in today's revenue recognition guidance.
- The standard will apply to a company's contracts with customers, except for contracts that are within the scope of other standards (e.g., leases, insurance, financial instruments). Elements of contracts or arrangements that are in the scope of other standards (e.g., leases) will be separated and accounted for under those standards.
- The unit of account for revenue recognition under the new standard is a performance obligation (a good or service). A contract may contain one or more performance obligations. Although defined differently, the closest analogy in today's vernacular to a performance obligation would be a "deliverable" under the multiple element arrangement revenue guidance.
- Performance obligations will be accounted for separately if they are distinct. A good or service is distinct if the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer, and the good or service is distinct in the context of the contract. Otherwise performance obligations will be combined with other promised goods or services until the entity identifies a bundle of goods or services that is distinct.
- The transaction price is allocated to all the separate performance obligations in an arrangement. It reflects the amount of consideration to which an entity expects to be entitled in exchange for transferring goods or services, which may include an estimate of variable consideration to the extent that it is probable of not being subject to significant reversals in the future based on the entity’s experience with similar arrangements. The transaction price will also reflect the impact of the time value of money if there is a significant financing component present in an arrangement. The transaction price excludes amounts collected on behalf of third parties, such as some sales taxes.
- Revenue will be recognized when an entity satisfies each performance obligation by transferring control of the promised goods or services to the customer. Goods or services can transfer at a point in time or over time depending on the nature of the arrangement. Specific criteria are provided for when a performance obligation is satisfied over time.
- The incremental costs of obtaining a contract are capitalized if the costs are expected to be recovered. Costs incurred to fulfill a contract are capitalized if they are not covered by other relevant guidance, relate directly to a contract, will be used to satisfy future performance obligations, and are expected to be recovered.
- As amended, the FASB's standard is effective for public entities for the first interim period within annual reporting periods beginning after December 15, 2017 (nonpublic companies have an additional year). The FASB’s standard will allow early adoption, but no earlier than the original effective date for public entities (reporting periods beginning after December 15, 2016). The IASB’s standard, as amended, is effective for the first interim period within annual reporting periods beginning on or after January 1, 2018, with early adoption permitted.
- In May 2015, the FASB issued a proposal for public exposure to amend certain aspects of the new revenue standard, specifically the guidance on identifying performance obligations and accounting for licenses of intellectual property. The proposed amendments are intended to address implementation issues that were raised by stakeholders and discussed by the Transition Resource Group (TRG). Comments on the FASB’s proposal were due June 30, 2015.
- An entity can apply the new revenue standard retrospectively, including using certain practical expedients. Alternatively, an entity can choose to recognize the cumulative effect of applying the new standard to existing contracts in the opening balance of retained earnings on the effective date, with proper disclosures.
- During the FASB’s Financial Accounting Standards Advisory Council meeting, an SEC staff member indicated that the SEC will not object if companies that retrospectively adopt the revenue standard only recast the same years as presented in their primary financial statements in the five year selected financial data table (i.e., a company will not need to recast the two earliest years). However, companies that choose this option should provide transparent disclosure regarding the basis of presentation and lack of comparability.
- Existing revenue recognition guidance lacks consistency across industries and between US GAAP and IFRS, and fails to address certain types of arrangements. This new standard is aimed at reducing or eliminating those inconsistencies, thus improving comparability, and eliminating gaps in guidance.
- The new standard will significantly affect the current revenue recognition practices of many companies, particularly those that follow industry-specific guidance under US GAAP. We expect the Aerospace & Defense, Automotive, Communications, Engineering & Construction, Entertainment & Media, Pharmaceuticals & Life Sciences, and Technology industries to be impacted the most.
- Depending on an entity's existing business model and revenue recognition practices, the new standard could have a significant impact on the amount and timing of revenue recognition, which in turn could impact key performance measures and debt covenant ratios, and ultimately could affect contract negotiations, business activities, and budgets.
- All entities will likely have to consider changes to information technology systems, processes, and internal controls as a result of the new decision points and increased disclosure requirements, among other aspects of the model.
- In July 2015, the IASB issued its package of proposed amendments to the new revenue standard in response to implementation issues raised by stakeholders and discussed by the TRG. The IASB’s proposal includes amendments to the guidance on accounting for licenses of intellectual property and the principal versus agent assessment (gross versus net revenue presentation). The IASB is also proposing additional practical expedients related to transition and amendments to the illustrative examples accompanying the new revenue standard. Comments were due October 28, 2015.
- In August 2015, the FASB issued its proposal related to the principal versus agent assessment, which mirrors the IASB’s principal versus agent proposal. Comments were due October 15, 2015. The boards expects to issue their final amendments in 2016.
- In September 2015, the FASB issued its proposal to amend the guidance on collectibility, completed contracts at transition, and noncash consideration, and add new practical expedients for the presentation of sales taxes collected from customers and the accounting for contract modifications at transition. Comments were due November 16, 2015. The FASB is in the process of reviewing responses received and expects to issue its final amendments in 2016.
Identifying performance obligations is the second step in the new revenue model. Listen in to hear how to take that one small step, in what’s going to be a giant leap of implementation. Hear PwC’s Michele Marino define what a performance obligation is, the criteria for determining whether goods or services in a contract should be accounted for separately or as a group, and share an example of applying the guidance.
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