All entities will have to reevaluate their revenue recognition processes when the Financial Accounting Standard Board (FASB)'s Accounting Standard Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606) is adopted, beginning with those early adopting in 2017.
Manufacturing companies face unique considerations with the new revenue recognition guidance. They should consider how the following situations and scenarios may be affected by the ASU now in order to prepare for the guidance's effective date.
Revenue Recognition Methods That Could Change
Over-Time Recognition: Under existing guidance, manufacturers generally recognize revenue at a point in time, such as when a product is shipped or delivered. The new guidance will require consideration if point in time recognition continues to be appropriate. Under Topic 606, the reporting entity recognizes revenue when it transfers control of the contracted good or service to the customer. The guidance for when control is transferred over-time may result in more performance obligations being recognized over time. For instance, certain types of manufacturers such as "job shops" that create unique products to customer specifications may recognize revenue over time under Topic 606 if the good manufactured does not have an alternate use for the manufacturer and the manufacturer has a right to payment.
The new standard specifics that entities can recognize revenue over time if one of the following are present:
- Customer receives and consumes the benefit as the performance occurs;
- The performance creates or enhances an asset the customer controls; or
- The performance creates an asset without an alternative use to the entity, and the entity has a right to payment for performance completed to date.
A manufacturer recognizing revenue over time will be required to determine an appropriate method of recognition, which may include a method based on cost (similar to the percentage of completion method under existing standards) or based on time, milestones or other relevant metrics.
Point in Time: Revenue that does not meet the criteria for over-time revenue recognition must be recognized at a point in time. Unlike existing guidance that emphasizes an analysis based on the transfer of risk and rewards, Topic 606 provides multiple, evenly weighted indicators to use when evaluating if control has transferred at a point in time including:
- The reporting entity has a right to payment,
- The customer has taken legal title,
- The customer has physical possession,
- The customer has significant risks and rewards, and
- The customer has accepted the good or service.
Sell-Through Method: In current guidance, manufacturers may recognize revenue using the sell-through method if a price is not fixed or determinable when a sale occurs to a distributor. Under the sell-through method, the manufacturer recognizes revenue when the product is sold to the end user. The new guidance will require manufacturers to estimate the amount of consideration and recognize revenue when they have transferred control of a good or service to a distributor. The estimation process will be complicated by the application of the constraint on variable consideration. To the extent that consideration is variable, such as due to a potential price concession, the manufacturer may only recognize revenue at the time control is transferred to the extent it is probable a significant reversal of revenue due to reductions in the estimate of variable consideration will not occur.
Bill and Hold: Non-public entities have not had guidance on the accounting for bill and hold transactions and have often referred to strict rules-based interpretation from the Securities and Exchange Commission (SEC). The SEC guidance currently has seven criteria an entity must meet to use the bill and hold method of revenue recognition. Among the criteria are a fixed-delivery schedule and that the buyer requested a deferral for a "substantive" reason. The new guidance provides explicit guidance that is applicable to all entities and focuses on meeting only four criteria:
- The reason is substantive,
- The product is separately identified,
- The product is ready for physical transfer, and
- The entity cannot be able to use or redirect the product.
Complex Areas in the New Guidance
A number of principles in the new guidance may be complicated for manufacturers to implement. Examine these areas of the revenue recognition standard now to determine how the process of recognizing revenue may change under Topic 606:
Variable Consideration: In determining the purchase price for the contracted transaction, entities may have to estimate variable consideration. Forms of variable consideration that will be common for manufacturers include: coupons, rebates, volume discounts, price protection, rights of return and price concessions. Manufacturers will have to estimate the variable consideration using either the most likely amount or the expected value of the consideration. Entities recognize variable consideration only to the extent that it is not probable that a significant reversal will occur, and they must update the estimate of variable consideration each reporting period.
Time-Value of Money: Payments for goods and services may come before or after control of the good is transferred to the customer. If the period between transfer of control and receipt of payment exceeds a year, entities must consider whether a significant financing component exists as part of their revenue recognition process. Financing exists when there is an explicit or implicit significant benefit to financing.
It does not exist if:
- Payment was received in advance and transfer was at the discretion of the customer;
- Consideration is variable based on a future event not controlled by the customer or the manufacturer; or,
- There is a timing difference for reasons other than financing, and the timing difference is proportional to those reasons.
Manufacturers that have contracts that include significant financing will be required to recognize interest income or expense to properly account for the financing aspect of the transaction.
Multiple Performance Obligations: A manufacturer is required under the new guidance to determine if it has promised to deliver more than one distinct good or service (or bundle of goods and services) in a contract. Determining the distinct performance obligations within a contract under the new guidance may be challenging to manufacturers. In some instances, services, free products, or other offerings that are currently not accounted for separately for revenue recognition may now be recognized separately based on an allocation of the transaction price.
Under the new guidance, warranty provisions must be reevaluated. Extended warranties and warranties that provide services other than assurance that a product complies with its specifications are accounted for as separate performance obligations within a contract under Topic 606. Offers of significant discounts, loyalty programs and other options may also be accounted for as separate performance obligations in the new guidance.
More Changes to Topic 606 Expected
Since the announcement of the new revenue recognition guidance, the FASB has made several modifications to the ASU. It deferred the revenue recognition standard by one year and has also proposed changes to identifying performance obligations, evaluating licenses, and principal versus agent considerations. Several practical expedients have also been proposed to make the guidance easier to apply. A sales tax practical expedient similar to existing guidance has been proposed that would permit all sales taxes to be presented net. The FASB also proposed a clarification that would cause shipping to generally not be a distinct performance obligation. Proposed practical expedients for transition to the new guidance would simplify the transition for long-term and completed contracts.
MHM will keep you up-to-date as further guidance and changes are released. For specific comments, questions or concerns about the revenue recognition standard, please contact James Comito, Brad Hale or Mark Winiarski of the MHM Professional Standards Group. James can be reached at firstname.lastname@example.org or 858.795.2029. Brad can be reached at email@example.com or 727.572.1400. Mark can be reached at firstname.lastname@example.org or 816.945.5614.
Published on November 02, 2015