Basic principles of the new revenue recognition standard

What is revenue recognition?

Revenue is one of the most important measures of financial performance in a business. Currently, US GAAP has complex, detailed revenue recognition requirements for specific industries and accounting transactions.  As a result, various industries may adopt different accounting for similar transactions.

 This often leads to inconsistencies and inaccuracies which may lead to misleading interpretations. As a result, investors, lending institutions, and other 3 rd parties may find it difficult to take important decisions. Therefore, it is extremely important to define and provide a detailed accounting standard.

 

Why is this important and relevant to your business?

Modern day business involves complex terms and conditions.

Eg:

Software company: Purchase and delivery of the software via CD or online. When should you record your revenue? At the time of the order was made online or when the CD was actually shipped? 

Cell phone manufacturing company: When should you record the revenue? When the order placed online by the customer or when it was shipped to the customer?

Achievement of milestones- research-based or project-based businesses: Eg: Once the research and development have reached a certain milestone, there may be few payment terms associated with it.

Shared office spaces: Should you record the revenue after the time has lapsed and tenant utilized the space or when the customer books the appointment online.

eCommerce companies: Should the revenue be booked after the product was shipped or when it was placed online.

 

As you can see, without proper guidelines each company may adopt their own revenue recognition standards and book revenue accordingly. Therefore, review the below guidelines that provides an overview of what, when and how to book your revenue.

 

 Objectives of the new revenue recognition standard are as follows :

 1) Consistency and comparability: Increase comparability across capital markets and industries.

2) Additional disclosures: Provide guidelines for additional disclosure that can be used by investors, lending institutions, and others. This is to provide a more detailed information that provides insight behind the numbers.

3) Comprehensive framework: Providing a robust framework for addressing revenue issues as they surface.

  The core principle of the new guidance.

As per Financial accounting and standards board, the core principle  is to "Recognize revenue in a manner that depicts the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services"

 A company will need to apply the following five steps to achieve the core principle as per FASB's new guidance.

 

 1) Identify the contract with the customer.

2)  Identify the performance obligations of the contract.

3)  Determine the transaction price.

4)  Allocate the transaction price to the performance obligations of the contract.

5) Recognize revenue when the organization satisfies the performance obligation.

 

TIMELINES FOR ADOPTING THE NEW REVENUE RECOGNITION STANDARD ASC 606

 

ASC 606 is the new revenue recognition standard that takes effect for most public listed companies in the United States effective January 2018. 

Below list has some important information relating to when both public and non-public listed companies will need to adopt the new Revenue Recognition standards :

1) Non-Publicly listed companies : Non-publicly listed companies reporting under US GAAP are required to apply the new standard for annual period starting after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019

2) Publicly listed companies : US GAAP requires publicly listed companies to apply new the new revenue recognition standard beginning after December 15, 2017. Early adoption is permitted  i.e for annual periods after December 15,2016 including interim reporting periods within that reporting period.

 

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Posted In: Financial statement audits, reviews and compilations

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