How to Recognize Revenue: Exploring the New Standard’s Goals, Effects & Transition
Revenue is a key factor for investors when determining a company’s viability. The Financial Accounting Standards Board (FASB) issued ASC 605, Revenue Recognition, as amended by Accounting Standard Update (ASU 2014-09), Revenue from Contracts with Customers. This updated model provides guidance for transaction-specific revenue recognition and matters related to revenue-generating activities, including the sale of products, rendering of services, and gain/loss on involuntary conversions of nonmonetary to monetary assets. This new standard applies to all types of entities across all industries, with a small handful of exceptions. Its goal is to eliminate the discrepancies and complexities that have often been present in the varying GAAP requirements placed on different industries and transactions by providing a more straightforward, universal framework.
The core principle of revenue recognition, under the FASB’s updated standard, is to identify revenue as a depiction of the transfer of promised goods or services to customers in an amount that reflects what the given entity expects to receive in exchange for those goods or services.
There are five steps to achieve the core principle in accordance with the new standard:
- Identify the contract with a customer – understand the rights and obligations created by the arrangement.
- Identify the performance obligations in the contract – establish the deliverables of the arrangement.
- Determine the transaction price – what amount does the entity expect to receive?
- Allocate the transaction price to the performance obligations – the amounts expected for each separate performance obligation should be allocated based on relative stand-alone selling prices.
- Recognize revenue when / as the performance obligations are satisfied – once Steps 1 through 4 have been completed and the revenue recognition timeline is determined, the entry can be made. If payment was received in advance, the standard refers to it as a “contract liability,” which is deferred revenue. If revenue was earned, but not yet received, a receivable is recorded.
Effects of the New Guidance
The new guidance on revenue recognition affects any reporting organization that either enters into contracts with customers to transfer goods/services, or enters into contracts for the transfer of nonfinancial assets – unless those contracts are within the scope of other standards (for example, insurance or lease contracts).
A wide assortment of new disclosures is expected to be one of the biggest challenges for financial statement preparers as they implement the new revenue recognition guidance.
Companies are required to disclose revenue and impairment losses from contracts with customers separately from other sources of revenue or impairment. Qualitative and quantitative disclosures are required, including the following:
- Disaggregation of revenue – disclose the relationship of the disaggregated.
- Contract balances – disclose opening and closing balances.
- Performance obligations – disclose when the performance obligation is satisfied.
- Remaining performance obligations – disclose the allocated transaction price to the remaining obligations, and disclose when the company expects to recognize the remaining contract revenue.
- Significant judgments and estimates – disclose the judgment and estimate of when revenue is recognized, the transaction price, and allocation of performance obligations.
- Policy decisions – disclose decisions related to any practical expedients used by the company, such as whether a significant financing component exists, or the expedient used as a response to the incremental costs of obtaining a customer.
Public organizations must apply the new revenue standard to annual reporting periods beginning after December 15, 2017, while nonpublic organizations should apply the new revenue standard to annual reporting periods beginning after December 15, 2018.
Early adoption of the new standard is permitted for both public and nonpublic organizations, but not before the original public organization effective date (annual periods beginning after December 15, 2016).
While the FASB and other organizations offer helpful guidance for implementation and compliance with changing revenue recognition standards, we always recommend using a qualified audit expert to guide you through the concerns and questions specific to your company. For information on revenue recognition or our services, please contact us at email@example.com or
Sharon Jones, CPA, Series 7 & 63, is an Audit Senior Manager at Farkouh, Furman & Faccio with over 22 years of combined public and private experience. Sharon specializes in the Financial Services industry with a concentration in Hedge Funds (including complex capital structures such as Offshore Funds, Master Feeder Structures and Fund of Funds), Mutual Funds, Private Equity, Registered Investment Advisors, Management Companies, Broker Dealers, Commodity Pool Operators and Future Commission Merchants.