If your company hasn’t yet begun implementing the changes to revenue recognition, now is the time to start.
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, which introduced Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers. ASC Topic 606 supersedes long-standing, industry-specific guidelines and fundamentally changes how companies across nearly every industry should recognize revenue.
While some companies have adopted ASC Topic 606 prior to the recent issuance of ASU 2020-05, which deferred the effective date, others have yet to implement the new accounting standard. Here are four considerations for your entity as it begins its revenue-recognition implementation efforts.
ASC Topic 606 was the result of the FASB’s joint project with the International Accounting Standards Board (IASB) to improve the financial reporting of revenue. Legacy Generally Accepted Accounting Principles (GAAP) is composed of broad revenue recognition concepts and detailed guidance for particular industries, which often resulted in different accounting for similar transactions.
The purpose of the new revenue recognition standard is to eliminate inconsistencies in how businesses across industries account for similar revenue transactions by providing a comprehensive revenue recognition model that applies to a wide range of industries.
Using a new five-step accounting process, ASC Topic 606 establishes comparability within financial reporting across industries by applying a uniform framework to revenue recognition. Much of legacy GAAP is built around a risks-and-rewards notion, where revenue is recognized when substantially all of the risk of loss from the sale of goods or services has passed to the customer. In contrast, the trigger for revenue recognition under ASC Topic 606 is based on the transfer of control of a good or service to the customer.
The basic principle within ASC Topic 606 is that a company should recognize revenue when it transfers goods or services to a customer in an amount in which it expects to be entitled to receive from the customer. The new five-step revenue accounting process is as follows:
The new model may lead to different revenue recognition patterns and amounts, as compared to legacy GAAP. This means that companies must analyze their contracts and apply significant judgment to determine when the control of goods or services has occurred and to determine the amount they’re expected to be entitled to receive in return.
While there are some narrow scope exceptions, generally, all revenue streams should be assessed under the new standard.
Companies need to perform a thorough analysis of all contracts with customers. A contract with a customer is in the scope of ASC Topic 606 if all of the following conditions are met:
If an agreement meets the above criteria, the contract should be evaluated under the ASC Topic 606 five-step process to determine the timing and amount of revenue recognition.
To achieve the core principle of the new revenue standard, contracts with customers within the scope of ASC Topic 606 must be assessed under the following five-step process.
To learn more about how to apply each of these five steps, see our Revenue Recognition Guide.
Along with the amended accounting guidance, ASC Topic 606 requires additional revenue disclosures, both qualitative and quantitative. The objective of the added disclosures is to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. To learn more about the additional revenue disclosures, read our article.
While nonpublic companies may elect not to provide certain disclosures, they’re still required to disclose information about contracts with customers—including disaggregation of revenue, contracts balances, and performance obligations—and the significant judgements made in applying the guidance within ASC Topic 606. Nonpublic companies must also disclose information regarding their accounting policies and the transition method and related effects of adoption.
As a result, many companies will likely need to update their accounting policies and will find their revenue recognition disclosures greatly expanded as compared to previous guidance.
If your company hasn’t yet begun implementing ASC Topic 606, it will need to act quickly to meet all accounting, presentation, and disclosure requirements.
The amendments in ASU 2020-05 defer the required effective date of ASC Topic 606 for one year for certain entities that haven’t yet issued their financial statements—or made financial statements available for issuance—reflecting the adoption of ASC Topic 606.
Those entities may elect one of the following options:
To learn more about the new revenue recognition standard or how it may impact your company, read our Revenue Recognition Guide or contact your Moss Adams professional.