The Financial Accounting Standards Board’s (FASB) update to revenue recognition is going to impact nearly everyone across all industries. But what are these new standards and why won’t your accountant stop talking about it? When it comes to the new revenue recognition standards, here’s the gist of it: Accounting Standards Update 606 (ASU 606) deals specifically with recognizing revenue from customers with contracts. If you are sighing in relief because this does not apply to you, think again. ASU 606 states that contracts can be written, oral, or even implied. At its core, ASU 606 attempts to more accurately align the recognition of revenue with the completion of the contract, or even more accurately, the completion of performance obligations within the contract.
Now that we have an understanding of the scope and objective of ASU 606, let’s talk about how to implement it and what kind of financial reporting requirements you need to know. The FASB has provided a five step process for recognizing revenue from contracts with customers:
Step 1 – Identify the Contract.
In previous standards this was pretty straight forward. With ASU 606, one of the biggest changes is the requirement to combine multiple contracts into one for the purpose of financial reporting. This is required if the contracts have the same commercial objective, are interdependent, or share a single performance obligation.
Step 2 – Identify Performance Obligations.
Once all contracts have been identified, and if necessary, combined, we are now required to identify each distinct or “bundled” performance obligations within each contract. These performance obligations will now be our benchmarks for when and how we recognize revenue.
Step 3 – Determine the Transaction Price.
Gone are the days when the stated price of the contract is the determining factor for actual value of the contract. Instead, we must now determine the transaction price of the contract by estimating the consideration we expect to be entitled to upon completion of the contract.
Step 4 – Allocate the Transaction Price.
We suspect that of the five steps in ASU 606, this will be the one that most people get hung up on. There are three methods available for use when allocating the transaction price among it’s performance obligations. These methods are the adjusted market approach, the expected cost plus margin approach, and the residual approach. Each method requires an in depth discussion to truly understand proper application, but for brevities sake, identification of these methods will have to do.
Step 5 – Recognize Revenue.
It is finally time to recognize revenue! Revenue is recognized as performance obligations are satisfied. The key point to remember about this step is that revenue should be recognized either over time, or at a point in time, and that these two approaches are mutually exclusive from each other.
If you are still wondering what all of this means for you and your business, don’t go it alone! Contact your accountant to help guide you through.
By Melissa Liu and David Hegstrom, Harris CPAs
