Private companies and not-for-profit organizations, you cleared the biggest hurdle to revenue recognition adoption and busted some of the important myths. Now comes the hard part: a formal, initial impact assessment.
In the race for ASC Topic 606 adoption, your assessment of how revenue recognition affects your organization serves as your course map. It highlights the contracts and arrangements that will experience some of the biggest changes under the new accounting standard, so that you can see other potential barriers between your organization and the finish line.
With the right course map, private companies and not-for-profit organizations will also have a solid estimate of the financial impact of the new standard. The financial changes, if significant, will need to be reviewed with your financial statement auditor and disclosed to your financial statement stakeholders.
But saying your organization needs the formal initial impact assessment and completing the assessment are two different things. By breaking down the assessment into different components, your organization can ensure that it has the understanding and the resources to get the job done—and quickly—considering Dec. 31, 2019, the end of the first year of mandatory adoption draws closer by the day.
Laying the Parameters
The impact assessment is the 10,000 foot view of how Topic 606 affects your organization. It is not the time to apply the standard to every single contract. Instead, your organization needs to select a representative sample of contracts. The representative sample should include the contracts that have the biggest monetary impact on your organization, the types of contracts that would be “typical” for your organization, and the contracts with such nuance that they may be difficult to transition.
Start With Your Transition Approach
Companies have two options for their Topic 606 adoption: the full retrospective approach and the modified retrospective approach. Under the full retrospective approach, the standard must be applied to all contracts that are presented in the adoption year financial statement, even the completed contracts. Under the modified retrospective approach, companies only apply the standard to contracts that were ongoing at the first date of adopting Topic 606. If you choose to use the full retrospective approach, you will need to include completed contracts in your sample contract evaluation pool.
Individual contracts may be nuanced, but they may also have terms and conditions that share similarities with other contracts. Companies should group together contracts with similar terms and conditions.
Get Sign Off
Revenue recognition adoption is a team sport. Before you have your sample finalized, ask other members of the organization for input. Consult with sales, internal audit, and legal to ensure you have captured the right mix of contracts.
Identify Who’s Doing the Work
Internal accounting departments may be able to do take the sample contracts and walk them through Topic 606’s five-step model, but they may not have the resources to take it on. One of the reasons why those of us in accounting have been pushing the urgency with revenue recognition adoption is because the review of contracts takes time. As we get closer to the end of the year, accountants’ time is in shorter supply. Check with your internal accounting team about their bandwidth, and if you need to, consider enlisting a broader bench of accounting support to complete the impact assessment.
Create a Checklist
Once you have assembled your revenue recognition work team, make sure they have their revenue recognition map in hand. Topic 606 spells out the five-step model, but your organization will want to ensure it uses something that’s more customized. Consider creating a checklist for adoption that captures the five-step model as it applies to the types of contracts in your representative sample. A customized checklist helps ensure that the standard is applied consistently to each contract type and may help expedite your organization’s full adoption efforts.
Several elements of the Topic 606 revenue recognition standard contain qualitative elements, which means some judgment will be involved in how Topic 606 is applied. During the initial impact assessment, your team should take notes about judgments and conclusions reached during the major decision points in the standard. Examples of these decision points include the process of determining whether the customer is the principal or the agent in a contract.
Look at Your Results
To get to the financial impact of the standard change, you will need to actually complete the five-step model for a contract and review your results. What were the changes to the timing of revenue recognition for most of your contracts? This is also a good opportunity to also test any automation rules in your accounting systems that you will be using to apply the revenue recognition standard to contracts outside of the representative sample. Did the automation rules work as anticipated? These are crucial questions to answer and address before the full adoption begins.
For More Information
An experienced accounting provider can be a vital coach or even a relay partner in your revenue recognition adoption race. For more information about the initial impact assessment for revenue recognition, please contact us.
Published on August 13, 2019