Implementing Revenue Recognition for Your Private Company

Implementation of the new revenue recognition standard, Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, is almost here. For a private company, the standard will go into effect for calendar years beginning after Dec. 15, 2018. As such, companies should begin assessing now the impact of the new guidance.

Items to Consider Today

The new standard is one of the most extensive changes to revenue recognition standards that U.S. GAAP has seen in recent years. In addition, the impact is to the recognition of a company’s revenue, the foundation of an entity’s performance measurements. The challenge with the new standard is that some companies will see a significant impact to their financials (including to the actual revenue recognized), whereas others will see only a slight impact (potential disclosure impact only and no impact to the revenue recognized).

Regardless of where a company falls on the spectrum of impact, there are a few items that are certain with the new guidance:

• Implementation of the new standard will take more time and effort from management than most new accounting standards.
• Implementation of the new standard will most likely involve departments outside of accounting (i.e., information technology, human resources, and/or sales).
• The new standard is a “principles-based” approach, meaning there will be a greater amount of management judgment when applying the standard.

It is also important to point out that most companies are recognizing revenue based on daily activities. As such, this standard will not be able to be applied at the end of the year as part of the closing process before year-end financial statements are finalized. Implementation will need to be an all hands on deck approach from the start, as the information needed to implement (and meet disclosure requirements) will be derived from the daily activities that are driving the revenue generation. If management waits until year end to implement the new revenue standard, it might not have easy access to the information that is required to determine the recognition of the revenue or the information required to be disclosed in the footnotes to the financial statements.

Leadership on the accounting team will be key to the successful implementation of the new standard, with management needing to designate an individual to lead the project. It is important that this individual gain a solid understanding of the new standard and not be tied down by the existing guidance. This understanding can begin at a high level. Companies, however, will be required to drill down into the details and analyze all types of contracts to determine the effects the standard will have (if any).

With the new revenue standard being a more principles-based approach, it is also important that the individual leading the implementation is a strategic thinker who makes solid judgment decisions that can be supported. The judgment used by this individual could impact the amount and timing of revenue recognized.

Beyond the Accounting Department

Personnel within various departments outside of accounting may need to be involved with the implementation of the new standard, including:

• Information Technology (IT): If information is needed to assess contracts and/or comply with the new disclosure requirements, the IT department may need to help compile this information.
• Human Resources/Payroll: If a significant amount of compensation paid to employees is based on a revenue metric, then the accounting department will need to work with the human resources/payroll department to assess the impact on this compensation. In addition, incremental costs incurred to obtain a contract are capitalized and amortized over the life of the contract (as long as certain requirements are met), which could include commissions or fringe benefits paid to employees.
• Sales/Marketing: The sales/marketing department may need to help evaluate customer contracts to determine if the terms should be modified.

Contract Terms to Consider

As management evaluates the company’s individual contracts, several questions should be considered with respect to contract terms.

1. Are there terms in the contract that will be impacted by the new standard?
   1. Does the contract provide separate, distinct performance obligations or are there bundled performance obligations that are not distinct individually?
   2. Are the performance obligations identified satisfied at a point in time or over a period of time?
   3. Is the consideration to be received fixed or variable?
   4. Are there volume rebates or pricing step-up/down provisions?
   5. Are there minimum purchase commitments?
   6. Are significant contract modifications made frequently?
   7. Is the company creating a customized good?
   8. Are there any bill-and-hold arrangements?
   9. Are there costs incurred to obtain the contract?
   10. Is there a series of performance obligations in the contract?
   11. Is there a financing component to the contract?
   12. If the contract relates to the sale of a product, when does the customer obtain control?
2. Is all data needed available to evaluate the contract?
   1. For example, if the contract has a rebate, does management have adequate data on the rebate to determine its impact on the revenue recognized?
   2. Should the company implement any changes to its systems to ensure the data needed is readily available?
3. What accounting policies would the company need to change or adopt based on the contracts it has in place?
   1. For example, should the company adopt the practical expedient for shipping and handling costs?
4. Is there employee compensation that is based on a contract? If so, will it be affected?
5. Once assessed, will any change to the company’s revenue recognition related to the contract result in an impact to financial ratios or debt covenants that the company is required to maintain?
6. What items should be disclosed related to the contract? Is all data needed available for the disclosures?

Adoption Methods

The new standard provides for two methods of adoption: full retrospective and modified retrospective. Management will need to evaluate the two methods and determine which one most adequately meets the needs of both the company and the users of its financial statements.

Full Retrospective Method

With this method, the entity will report all periods presented under the new standard, with the option to elect any or all of the following practical expedients (which must be disclosed):

• For completed contracts, an entity does not need to restate contracts that both begin and end in the same reporting period.
• For completed contracts that have variable consideration, an entity may use the transaction price at the date the contract was completed rather than estimating variable consideration amounts in the comparative reporting periods.
• For all reporting periods presented before the date of the initial application of the new standard, the entity needs not disclose the amount of the transaction price allocated to the remaining performance obligations and an explanation of when the entity expects to recognize that amount of revenue.

Modified Retrospective Method

With this method, companies are able to apply the new revenue recognition standard to only the current year. To use this method (for nonpublic companies), any contracts that are open or new will be subject to the new standard’s requirements as of Jan. 1, 2019. Contracts that have been completed or are substantially complete at that date may be excluded. Contracts that are partially, not substantially, complete will require a cumulative-effective adjustment to the opening balance of retained earnings on Jan. 1, 2019.

Additionally, the entity must disclose the amount by which each financial statement line item is affected in the current reporting period by the application of ASU 2014-09, as compared to the guidance that was in effect prior to ASU 2014-09. This means that an entity will have a dual reporting requirement to account for revenue recognition under current U.S. GAAP to disclose the financial statement line item differences between the old and new U.S. GAAP revenue recognition standards.

New Disclosures

When considering the implementation of the new revenue standard, management should take into account the new required disclosures. The information needed for the new disclosures should be available and adequately captured to present in the footnotes. Given the increase in disclosures and required information, companies should plan accordingly and not wait until it is time to prepare the financial statements at year end.

Below is a general summary of the new required disclosures:

• Companies will be required to present or disclose revenue disaggregated separately by revenue from its contracts with customers (recognized in accordance with ASU 2014-09) and those revenue transactions accounted for in accordance with other accounting standards.
  • The standard also requires an entity to disaggregate revenue from contracts with customers into categories that depict how the nature, amount, timing, and uncertainty of revenue and cash flows are affected by economic factors.
    • Examples include major product lines, geographical regions, types of customer classes, etc.
  • The standard requires this disaggregated revenue disclosure to be reconciled to the revenue presented in the financial statements.
  • The standard does allow nonpublic companies to elect not to apply this new quantitative disaggregation of revenue disclosure requirement. However, if a nonpublic entity elects not to quantitatively disclose disaggregated revenue, it will be required to disclose qualitative information related to economic factors that affect the nature, amount, timing, and uncertainty of its revenue. Additionally, nonpublic companies will still be required to disaggregate revenue according to the timing of revenue recognition (a point in time versus over time) and disclose in their footnotes.
• Companies need to disclose information about the performance obligations in their contracts, including when the entity typically satisfies a performance obligation.
• Companies will need to disclose significant payment terms (e.g., payment due dates, if variable consideration exists, if there are any financing components, etc.).
• Companies will need to disclose the nature of the goods and services they provide.
• Companies will need to disclose any obligations they have for returned products, refunds, or any other similar obligation.
• Companies will need to disclose any type of warranty they provide and any related obligations.
• Companies are required to disclose amounts of revenue that have been recognized in the current period that are not the result of current period performance.
• Companies will need to disclose the aggregate amount of transaction price that has been allocated to performance obligations that are not satisfied as of the end of the reporting period and an explanation for when the company expects to recognize this revenue.
• Private companies will need to disclose any of the practical expedients that they have adopted that are allowed within the standard.

It is important to note that the method of adoption impacts the disclosures. If management applies the full retrospective method, the above disclosures must be made for each period presented on the financial statements. If management applies the modified retrospective method, the disclosures would only be required for each period presented after the initial application. The additional disclosures noted above related to the modified retrospective approach must also be made.

Now is the time for companies to begin assessing the impact the new standard will have on their approach to revenue recognition. What’s more, they will want to make sure that they have strong systems and processes in place for the implementation of this new guidance and that they can support their judgments and assumptions with good, solid information.