Introduction to the New Standard
The new revenue recognition accounting standard, effective for middle market nonpublic businesses starting from fiscal years beginning after December 15, 2018, brings about fundamental changes in how companies recognize revenue. This standard enforces a structured five-step process that companies must follow to appropriately recognize revenue.
The Five-Step Process
- Identifying Customer Contracts
The first step involves identifying the customer contract that forms the basis of revenue recognition. This includes determining the rights and obligations of both parties involved.
- Identifying Performance Obligations
This step requires companies to identify the distinct performance obligations within the contract – essentially, the individual goods or services promised to the customer.
- Determining Transaction Price
Here, companies need to establish the transaction price, which includes consideration of variable amounts, potential discounts, and any non-cash elements.
- Allocating Price to Performance Obligations
In this step, the transaction price is allocated to the various performance obligations identified earlier, based on their relative standalone selling prices.
- Recognizing Revenue as Obligations are Fulfilled
Revenue is recognized as each performance obligation is satisfied, meaning that control of the promised good or service is transferred to the customer.
Shift in Revenue Recognition
One notable change in this standard is the shift from recognizing revenue upon delivery to recognizing revenue when control of the product or service is transferred to the customer. This shift might lead to earlier revenue recognition for some companies, especially in cases where customization is involved.
Variable Consideration and Disclosures
The new standard mandates the inclusion of variable consideration, such as volume discounts and rebates, in the revenue recognition process. Additionally, new financial statement disclosures are required, encompassing disaggregated revenue details, performance obligation information, payment terms, and more.
Impact and Adjustments
The implications of the new standard are far-reaching, affecting areas such as bonus compensation plans, debt covenant compliance, revenue-related business projections, and customer contract analysis. Furthermore, companies must adapt their internal controls to ensure compliance with the new standard.
Companies have two options for transitioning to the new standard:
- Full Retrospective Method: This involves applying the standard to all presented periods, with the option to use practical expedients to ease the transition.
- Modified Retrospective Method: This approach allows companies to apply the standard to the current year while making adjustments for partially completed contracts.
Seeking Expertise for Implementation
To navigate the complexities of implementation, companies can enlist the expertise of firms like LBMC. These professionals can aid in developing an implementation plan, assessing the effects of the standard, and ensuring compliance. Their services encompass contract evaluation, revenue process analysis, internal control adjustments, and impact assessment.
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