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The new revenue recognition accounting standard, effective for middle market nonpublic businesses starting from fiscal years beginning after December 15, 2018, brings about fundamental changes in how companies recognize revenue. This standard enforces a structured five-step process that companies must follow to appropriately recognize revenue.
One notable change in this standard is the shift from recognizing revenue upon delivery to recognizing revenue when control of the product or service is transferred to the customer. This shift might lead to earlier revenue recognition for some companies, especially in cases where customization is involved.
The new standard mandates the inclusion of variable consideration, such as volume discounts and rebates, in the revenue recognition process. Additionally, new financial statement disclosures are required, encompassing disaggregated revenue details, performance obligation information, payment terms, and more.
The implications of the new standard are far-reaching, affecting areas such as bonus compensation plans, debt covenant compliance, revenue-related business projections, and customer contract analysis. Furthermore, companies must adapt their internal controls to ensure compliance with the new standard.
Companies have two options for transitioning to the new standard:
To navigate the complexities of implementation, companies can enlist the expertise of firms like LBMC. These professionals can aid in developing an implementation plan, assessing the effects of the standard, and ensuring compliance. Their services encompass contract evaluation, revenue process analysis, internal control adjustments, and impact assessment.
Starting in 2018 for public companies and 2019 for other entities, revenue must be reported using the new principles-based guidance found in Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. The updated guidance doesn’t affect the number of revenue companies report over the life of a contract. Rather, it affects the timing of revenue recognition.
The purpose of this change is to converge with the International Accounting Standards Board (IASB). The goal is to remove numerous inconsistencies between the FASB and IASB revenue recognition standards. These changes require entities, including not-for-profits, to clearly identify performance obligations in existing contracts, reapportion revenue at each contract revision or change and defer expense recognition to match with the contract’s delivery. With this being the case, contract add-ons and contract renewals must be aligned into a single contract and will prompt reallocations across both past and future periods – which can cause numerous revisions to revenue allocations and expense alignment.
With over 200 revenue recognition standards in the United States, the new principle-based standard focuses on the contract between the entity and consumer for the agreement of services or goods, and it also focuses on the rights and duties between the two parties.
The most important change is there are now five steps in the revenue recognition process.
Earnings before interest, taxes, depreciation, and amortization (EBITDA) will be changing as well. This is because the “right to use” asset that is set for the lease is amortized over the lease term. This changes it from an operating expense to a reduction of lease obligation while amortization expenses are recorded to reduce the right to use the asset.
Generally, leases will be on the balance sheet, and it is important to remember that leverage ratios will be changing and liabilities will be increasing. For some entities, this change will be extraordinary. For example, if a company has $500 million in liabilities and $500 million in equity and $200 million in future operating lease obligations, then they would have a leverage ratio of 1:1. In this example, when leases are recorded as a liability on the balance sheet, the leverage ratio would go to 1.4:1, which is a substantial change.
When it comes to revenue, auditors customarily watch for fictitious transactions and premature recognition ploys. Here’s a look at some examples of critical issues that auditors may target to prevent and detect improper revenue recognition tactics.
Considering the new revenue recognition standard, companies should expect revenue to receive renewed attention in the coming audit season. Contact us to help implement the new revenue recognition rules or to discuss how the changes will affect audit fieldwork.
Some recommended steps for businesses to evaluate the ramifications of the new revenue recognition standards are:
LBMC Technology Solutions understands that navigating through these changes can be a monumental task. This is why we provide solutions that are automated, enabling companies to both manage revenue using current and new guidelines simultaneously. Our programs can offer you the ability to:
LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.
