New accounting standards you should know about.
Starting in 2018 for public companies and 2019 for other entities, revenue must be reported using the new principles-based guidance found in Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. The updated guidance doesn’t affect the number of revenue companies report over the life of a contract. Rather, it affects the timing of revenue recognition.
IASB & FASB – Streamlining Standards
The purpose of this change is to converge with the International Accounting Standards Board (IASB). The goal is to remove numerous inconsistencies between the FASB and IASB revenue recognition standards. These changes require entities, including not-for-profits, to clearly identify performance obligations in existing contracts, reapportion revenue at each contract revision or change and defer expense recognition to match with the contract’s delivery. With this being the case, contract add-ons and contract renewals must be aligned into a single contract and will prompt reallocations across both past and future periods – which can cause numerous revisions to revenue allocations and expense alignment.
Rule-based accounting to Principle-based focus
With over 200 revenue recognition standards in the United States, the new principle-based standard focuses on the contract between the entity and consumer for the agreement of services or goods, and it also focuses on the rights and duties between the two parties.
The most important change is there are now five steps in the revenue recognition process.
- Identify contracts
- Identify the separate performance obligations on the contract
- Transaction price determination
- Allocate transaction price to the performance obligations in the contract
- Recognize revenue when the entity satisfies its performance obligations
EBITDA & Leases
Earnings before interest, taxes, depreciation, and amortization (EBITDA) will be changing as well. This is because the “right to use” asset that is set for the lease is amortized over the lease term. This changes it from an operating expense to a reduction of lease obligation while amortization expenses are recorded to reduce the right to use the asset.
Generally, leases will be on the balance sheet, and it is important to remember that leverage ratios will be changing and liabilities will be increasing. For some entities, this change will be extraordinary. For example, if a company has $500 million in liabilities and $500 million in equity and $200 million in future operating lease obligations, then they would have a leverage ratio of 1:1. In this example, when leases are recorded as a liability on the balance sheet, the leverage ratio would go to 1.4:1, which is a substantial change.
Why does revenue matter in an audit?
When it comes to revenue, auditors customarily watch for fictitious transactions and premature recognition ploys. Here’s a look at some examples of critical issues that auditors may target to prevent and detect improper revenue recognition tactics.
- Contractual arrangements – Auditors aim to understand the company, its environment and its internal controls. This includes becoming familiar with key products and services and the contractual terms of the company’s sales transactions. With this knowledge, the auditor can identify key terms of standardized contracts and evaluate the effects of nonstandard terms. Such information helps the auditor determine the procedures necessary to test whether revenue was properly reported.
- Gross vs. net revenue – Auditors evaluate whether the company is the principal or agent in a given transaction. This information is needed to evaluate whether the company’s presentation of revenue on a gross basis (as a principal) vs. a net basis (as an agent) complies with applicable standards.
- Revenue cutoffs – Revenue must be reported in the correct accounting period, generally the period in which it’s earned. Cutoff testing procedures should be designed to detect potential misstatements related to timing issues, as well as to obtain enough relevant and reliable evidence regarding whether revenue is recorded in the appropriate period. If the risk of improper accounting cutoffs is related to overstatement or understatement of revenue, the procedures should encompass testing of revenue recorded in the period covered by the financial statements and in the subsequent period. A typical cutoff procedure might involve testing sales transactions by comparing sales data for a period before and after year-end to sales invoices, shipping documentation or other evidence. Such comparisons help determine whether revenue recognition criteria were met, and sales were recorded in the proper period.
Considering the new revenue recognition standard, companies should expect revenue to receive renewed attention in the coming audit season. Contact us to help implement the new revenue recognition rules or to discuss how the changes will affect audit fieldwork.
What’s Next for Your Revenue Recognition?
Some recommended steps for businesses to evaluate the ramifications of the new revenue recognition standards are:
- Inspecting revenue streams and contracts to target the specific revenue changes required and where these changes have the biggest impact
- Addressing the areas that may take longer to resolve first for the adequate lead time
At LBMC Technology Solutions, we understand that navigating through these changes can be a monumental task. This is why we provide solutions that are automated, enabling companies to both manage revenue using current and new guidelines simultaneously. Our programs can offer you the ability to:
- Automate processes for addressing all new ASC 606 and IFRS 15 rules for revenue reallocation and expense amortization
- At the transaction level, disclose the impact of changes with surety with automated dual treatment
- Clearly discern the impact of the new rules on entities results with revenue and expense forecasting
- Automate complicated subscription billing with full integration to revenue recognition.
Contact LBMC Technology Solutions today for additional help and information.