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Focus on Revenue Recognition: Getting Started

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The implementation of the new standard is expected to be a significant undertaking for most entities. Even if you do not expect a significant change in the accounting for revenue, the comprehensive nature of the change will require companies to look at their revenue with a clean sheet of paper approach, assessing each of the five steps for all significant revenue streams.
February 7, 2018

New revenue recognition rules will be effective January 1, 2019 for private companies with a calendar year end. The new standard is a complete overhaul of the authoritative guidance, moving from a legacy of over 200 pieces of mostly industry specific guidance to one comprehensive framework for all entities. The only revenue contracts that are outside of the scope of this standard are leases, insurance and financial instruments.

The expected benefits of the new standard include:

  • Consistent application across all customer contracts
  • Increased comparability across entities and industries
  • More robust guidance for addressing complex, judgmental issues
  • More useful information for financial statement users, primarily through a significant increase in required disclosures

The core principle of the new standard is to recognize revenue from customers in a way that reflects the entity’s transfer of promised goods and services at an amount that represents the consideration that the entity expects to receive in exchange for those goods and services. The new revenue recognition model uses five steps to achieve this principle:

  1. Identify the contract with the customer.
  2. Identify the performance obligations within the contract.
  3. Determine the overall transaction price of the contract.
  4. Allocate the transaction price between the identified performance obligations.
  5. Recognize revenue as performance obligations are satisfied.

Getting Started

The implementation of the new standard is expected to be a significant undertaking for most entities. Even if you do not expect a significant change in the accounting for revenue, the comprehensive nature of the change will require companies to look at their revenue with a clean sheet of paper approach, assessing each of the five steps for all significant revenue streams. Another key factor in the implementation is that the standard is designed to be applied at a contract level, with exceptions for some large groups of like transactions. For some entities, significant time and effort will be required to evaluate all contracts. Additionally, the new disclosure requirements are significant, even for private companies. The disclosures are linked to the determinations made at each step. So even if you do not expect a change in your accounting, you will still need to evaluate your contracts to get the disclosures right.

The Team

The first step is to identify the key players on your implementation team and assign responsibilities. Ultimately, the team will be responsible for working through:

  • The transition impact, including the selection of transition method and practical expedients
  • Drafting new accounting policies, incorporating elections available in the new standard
  • Evaluate the adequacy of current systems to maintain necessary data in a way that facilitates required remeasurements and disclosures
  • Identify changes to be made to current revenue recognition processes in light of new policy and system capabilities
  • Business impacts (contract negotiations, marketing programs, compensation structures, debt covenants, tax implications, etc.)
  • Controls around implementation and future state
  • Communication/ education plans

An effort of this magnitude will need a committed executive sponsor to drive the effort across the organization. Beyond that, teams will vary significantly based on a variety of factors, including the complexity of the revenue-producing activities, the organizational structure of the entity, the knowledge and availability of members, and planned reliance on third-parties for assistance, just to name a few. Consider the workload of the team members to ensure they are able to dedicate an appropriate amount of time to the effort.

It is important to ensure that team members responsible for the identification and review of contracts, and those charged with the analysis and review, have adequate knowledge of the standard as well as the underlying operations and transactions. This can be especially challenging for entities with decentralized revenue-generating operations and/or accounting functions. From the beginning, make sure that other departments (legal, sales, marketing, operations) understand the importance of this initiative and that the accounting team need may need assistance gather the necessary documents and interpret contract provisions.

Another point to consider is access to a complete and accurate population of executed contracts. Are all contracts readily accessible? Are they in English? How will you identify amendments, modifications, side agreements, written or oral? Are there customary business practices that are not part of your contracts that could impact revenue recognition?

Scoping

Now that you have a team assembled, ensure all revenue streams have been identified by reconciling revenue by stream to total revenue.

Once all of your steams are identified, create a plan for reviewing specific contracts within each stream. Along with materiality, consider the complexity and variability of contracts within each stream as these will impact the level of analysis needed for each stream. The level of effort will increase with the complexity and variability of the contracts within a stream. A stream that is comprised of complex transactions with significant variability and customization could likely require a detailed review of all material contracts. For streams with a large population of homogeneous transactions with system generated terms, it may be acceptable to take a portfolio-approach and review of a limited number of documents. In this situation, best practices would include an ongoing process to identify any exceptions to standard terms.

Throughout this process, communication with the audit team is critical. As each step builds on the ones before it, you should plan on regular touchpoints to ensure alignment through each stage.

Final Thoughts

Sometimes getting started on a project is the hardest part. While some implementations of the new revenue standard have been easier than others, we have already found several examples of entities that have underestimated the complexity of the new rules and the amount of time required for implementation.

 

Any federal tax advice contained in this communication (including any attachments): (i) is intended for your use only; (ii) is based on the accuracy and completeness of the facts you have provided us; and (iii) may not be relied upon to avoid penalties.

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