It is time to revisit the discussion on changes to revenue recognition. Just to recap, the new standard requires that revenue is recognized when goods or services are transferred to a customer and for the amount the seller expects to be entitled, based on the five step process (not necessarily performed chronologically):
- Identify the contract with the customer
- Identify the separate performance obligations
- Determine the transaction price
- Allocate the transaction price to the individual performance obligations
- Recognize revenue as the performance obligations are satisfied
The new standard is effective for privately held companies for annual reporting periods beginning after December 15, 2018, with early adoption allowed for annual reporting periods beginning after December 15, 2016 (calendar year 2017!)
It’s time to start talking about implementation and two methods are allowed:
- Full retrospective adoption with optional practical expedients would apply the new standard to all periods presented in the financial statements. The practical expedients are:
- Companies would not restate contracts that begin and end within the same reporting period.
- For completed contracts with variable consideration, the company can use the transaction price at the date the contract was completed rather than estimating variable consideration for the comparative reporting periods.
- Companies would not be required to disclose the amount of the transaction price allocated to uncompleted performance obligations and explanations of when the company expects to recognize that revenue for periods presented before the date of initial application.
- Modified retrospective adoption allows companies to apply the new standard to contracts that are outstanding as of the date of implementation. To elect this method, companies would examine those outstanding contracts and compare how the revenue would be recognized under the new standard versus existing GAAP. Any difference in revenue would be adjusted to beginning retained earnings. No adjustment would be made to prior periods presented. The modified retrospective method requires extensive disclosures on how amounts reported in the financial statements are impacted.
As we get closer to the date of implementation, companies need to decide which method of implementation would be the best method for the users of their financial statements. Companies who have significant balances in deferred revenue under current GAAP may find the full retrospective alternative the most advantageous. It is possible that using the modified retrospective method would require some of the deferred revenue to be adjusted to retained earnings, since prior periods are not restated. This method could result in “disappearing revenue” – revenue that would be adjusted from deferred revenue to retained earnings without ever being reported on the income statement.
Resources are available to help you get started or provide education on the basics. In my prior posts, I mentioned the FASB’s transition resource group. Updated information is available there on modifications to the new standards as well as practical expedients.
The AICPA also provides resources, including the Center for Plain English Accounting with a series on implementing the new standard. Check out the first excerpt which they are offering for free.
To review other Revenue Recognition blogs written by our team, click here.