With the new revenue recognition standard (ASU 2014-09) becoming effective for periods beginning after December 15, 2018, it is important for companies to begin understanding the new standard’s key changes, effects on financial reporting, internal process changes, and key elements of their specific industry that will be effected.
If you read our article last year, you’ll remember that the core principal of the new revenue recognition standard is to “recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” In applying this core principal, companies must apply the following five step process:
Step 1: Identify the contract with the customer
Step 2: Identify the performance obligations in the contract
Step 3: Determine the transaction price
Step 4: Allocate the transaction price to the performance obligation in the contract
Step 5: Recognize revenue when (or as) you satisfy the performance obligation
Discounts, rebates, and other incentives:
- Current guidance – accounted for as a reduction of revenue, as an expense, or as a separate deliverable.
- New guidance – treated as variable consideration which is included in the transaction price at the company’s best estimate and is included in revenue to the extent it is highly probably that there will be no significant reversal of the cumulative amount of revenue when any pricing uncertainty is resolved.
Contract manufacturing arrangements:
- Current guidance – treated as product sales and recognized as revenue when the manufactured goods are delivered to the customer.
- New guidance – if a company determines that it satisfies a performance obligation to manufacture goods over time, then it recognizes revenue over time (i.e. – as the manufacturing takes place) as opposed to recognizing revenue at a point in time (i.e. – upon delivery)
- Current guidance – If the warranty only covers compliance of the product with agreed-upon specifications then it is accounted for as a cost accrual.
- New guidance – If a customer can purchase the warranty separately or receives a service over and above guaranteeing compliance with agreed-upon specification then the company accounts for this as a separate performance obligation and allocates the transactions price to the product and the warranty. The warranty revenue would be recognized over the warranty period while the product revenue would be recognized at the point of sale.
- Current guidance states that companies adjust revenue for expected returns. The new guidance is very similar to this in that the Company still adjusts revenue for expected returns and recognizes a refund liability.
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