The time has arrived for revenue recognition adoption. Starting Jan. 1, 2017, all calendar year entities can elect to early adopt the changes announced under the Financial Accounting Standards Board (FASB)'s accounting standards update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606) (ASC Topic 606).
Regardless of whether your organization takes advantage of early adoption, implementation plans should be underway in 2017. All calendar year public business entities must adopt ASC Topic 606 by Jan. 1, 2018. All other entities must adopt the new standard by Dec. 31, 2019. Regulators will be looking for progress toward adoption much sooner; a recent U.S. Securities and Exchange Commission (SEC) staff comment asks that SEC registrants include their progress on revenue recognition as part of their year-end filing statements.
Transitioning to ASC Topic 606 will not be easy; it has a wide effect on operations and will require an overhaul of existing procedures and processes surrounding revenue streams. Organizations that ensure the following elements are part of its implementation strategy can ensure they are meeting their requirements for the new standard.
- Capture the 10,000-Foot Impact of the Standard on Your Operations
Revenue recognition under ASC Topic 606 can affect everything from human resources to accounting, finance, treasury, legal and human resources. Putting together a cross-functional team to evaluate where revenue recognition will have an impact is essential.
Certainly sales contracts and the resulting revenues will see the greatest impact. Although analyzing the contracts will require a detailed review at a high level, start by evaluating the broad impacts. Will revenue be deferred or accelerated compared to recognition today? This may occur for multiple reasons, including evaluating when transfer of control occurs, how revenues are allocated among performance obligations, how revenues are measured and the changes in the accounting for variable consideration. Will the accounting require tracking of additional sources of revenue in the form of performance obligations that are not currently accounted for as deliverables?
Entities should also consider whether adopting the revenue recognition standard will affect non-sales contracts, such as loan covenants. If timing of revenue recognition is going to change, it could affect EBITDA and working capital. Revised definitions of accounts receivable and contract assets could have an impact on your borrowing base. Sales commissions, bonus plans and stock-based compensation could also be affected by changes in the timing, allocation, or amounts of revenue.
If your cross-functional team is aware of all the elements that may be complicated by revenue recognition, it can have a better sense of what the implementation project will require of internal resources. It also can identify the changes that may need to be communicated to external parties, such as investors.
- Perform a Deep Dive of Existing Contracts
ASC Topic 606 will require every contract to be reevaluated. Using an evaluation tool for portfolios of contracts that have similar terms or for each identified revenue stream can expedite the process. Before using any evaluation tool, however, be sure to discuss your plan with internal and external stakeholders, including your organization's auditor. This step will help verify that the evaluation tool adequately demonstrates ASC Topic 606's impact on existing contracts and contract processes.
You should also understand the specific contract terms and how they are impacting revenue recognition. This may include involving an attorney to understand the legally enforceable rights and obligations under the contract. Numerous issues that are unexpected could arise from the deep dive into contracts, including the identification of significant judgments that must be made. Such judgments might include measuring variable consideration, deciding on the correct input or output method for recognizing revenue recognized over time or evaluating unique industry challenges.
In many cases when the rubber hits the road of evaluating the specifics of contract, a re-evaluation of the 10,000-foot impact may need to be performed as different aspects of the new guidance are discovered. For example, retailers may discover they have issues to account for related to breakage of gift certificates. A franchisor might uncover challenges with the recognition of initial franchise fees that may be recognized at a later date under ASC Topic 606, depending on the facts and circumstances involved. Brokerage firms or claims processors may find that their contracts contain more performance obligations that in current U.S. GAAP.
- Select a Transition method and Develop an Implementation Plan
Entities have two options for transitioning to the new standard, a retrospective and a modified retrospective approach.
A full-retrospective approach requires organizations to implement the standard for all periods presented in their financial statement in the year of adoption. If an organization adopts ASC Topic 606 in 2019 and does two-year comparative statements, it must report both 2019 and 2018 financial statements using ASC Topic 606. Disclosures of changes would be required for the 2018 financial statement. If choosing a retrospective approach, the timing and cost of preparing the accounting and auditing the changes to the prior year will be something to factor into the implementation plan.
A modified retrospective approach requires entities to take a cumulative period adjustment on its opening retained earnings in the year of adoption. On the surface, the modified retrospective approach may be more attractive because the retrospective approach will require revising the historical financial information and re-audit of prior year financial statements.
But the modified retrospective transition has its own set of considerations. In the year of adoption, entities must disclose what revenue would have been under previous U.S. GAAP (using ASC Topic 605) versus using ASC Topic 606. The disclosure essentially requires the entities to go through their financial statement reporting twice. The process will need to be documented to support the conclusion reached and the disclosures audited.
Other concerns may include the "lost revenue" issue, which may occur when the adoption of Topic 606 results in the acceleration of revenue. When this occurs, deferred revenue under Topic 605 that would have been recorded in prior periods under Topic 606 is removed from liabilities and recorded as an adjustment directly to retained earnings. As a result, an entity using the modified retrospective approach may experience a sudden decrease in revenues in the year of adoption relative to the prior period.
Organizations could also incur "double expenses." Take the following example. A software vendor pays commission based on expenses and recognizes the expense up front in 2018. It then adopts ASC Topic 606 for 2019. Under ASC Topic 606, if the license is longer than a year, commission would be recognized over the term of the license, which means a portion of those expenses would be pulled out of retained earnings and recognized again in 2018, thus resulting in the expense being recognized twice in a single set of financial statements under the modified retrospective approach.
Disclosures will also experience significant change. As part of the implementation plan consider what additional information will be required to be disclosed. For public business entities, many of these disclosures will include significant disaggregated quantified information. For private companies, the disclosures are reduced by comparison but significantly more then what is disclosed under current guidance.
Evaluating disclosure needs may also have a greater impact on the internal systems of your company. Ask, do systems currently gather sufficient information, disaggregated by revenue stream, to meet the disclosure requirements in Topic 606?
- Control Environment Updates
Controls should be in place for everything from pulling reliable data from past financial periods to the consideration of the new revenue recognition standard's impact on fraud risk.
There may be more judgment involved under ASC Topic 606 than previous U.S. GAAP. If a contract is determined to have variable consideration, for example, determining the variable consideration requires a degree of estimation. Internal controls should be able to demonstrate the process used to estimate variable consideration is reliable.
Ensuring that the changes made to the control environment and to reporting functions are transparent can also streamline your audit process.
Seek Help If Needed
Working with a provider that understands the standard and the potential ripple effect it could have on the various components of your operations may expedite the transition process. For more information on how to get started with revenue recognition adoption, contact Mark Winiarski, Brad Hale or James Comito of MHM's Professional Standards Group. Mark can be reached at firstname.lastname@example.org or 816.945.5614. Brad can be reached at email@example.com or 727.572.1400. James can be reached at firstname.lastname@example.org or 858.795.2029.
Published on December 06, 2016