Contracts with Customers: Revenue Recognition 5 Step Approach

Posted on 06.28.16

Contracts with Customers: Revenue Recognition 5 Step Approach

By Toby R. Leslie, CPA, Partner | Emerging Business Team

Unless you have lived under a rock for the last two years, you are probably aware that the Financial Accounting Standards Board (FASB) issued its new standard on revenue from contracts with customers (ASU 2014-09) in May of 2014.  The standard will replace all existing revenue recognition guidance and will apply to all entities who enter into contracts with customers unless those contracts are within the scope of other standards (i.e. insurance and lease contracts).  The standard will be effective for public entities for annual reporting periods beginning after December 15, 2017 (2018 calendar year ends) and all other entities for annual reporting periods beginning after December 15, 2018 (2019 calendar year ends).  Due to the long implementation period for the standard, many entities have “punted” in gaining an understanding and performing an assessment of how the new standard will impact their financial reporting.

Revenue Recognition Principle: 5 Steps

The core principle of ASU 2014-09 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 principle an entity must apply the following five step process:

Step 1 Identify the contract with a customer
Step 2 Identify the performance obligations (promises) in the contract
Step 3 Determine the transaction price
Step 4 Allocate the transaction price to the performance obligations in the contract
Step 5 Recognize revenue when (or as) the reporting organization satisfied a performance obligation

These steps may seem straight forward on the surface, however implementation of each step has its nuances.  While there is still several years before implementation of the standard, accounting systems and controls will need to be changed for many entities to account for the changes in reporting and consideration under the new standard.  Accordingly, entities should be acting now to assess controls and systems that need revision and the potential impact on their financial reporting.  Furthermore, either retrospective application is required to all periods presented or a single cumulative effect adjustment to the opening balance of retained earnings.  Thus, the systems and controls will need to be in place essentially one year prior to the implementation period. Some of the key areas with the most significant changes include:

  • Accounting for multiple deliverables in a contract, particularly those that sell software

  • Long term construction-type contracts

  • Loyalty programs and other payments and concessions to customers

  • Contracts with variable consideration

  • Warranties

  • Up-front costs to acquire customers

In next month’s article, I will go through in more detail several of the steps included in the five step approach and an implementation example.

Questions on this topic? Contact your Keiter representative or 804.747.0000 | Email

The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.

Posted by: Toby R. Leslie, CPA

Toby has over 15 years of experience at Keiter creating opportunities and providing accounting and auditing services.  He participates in various client services including financial statement audits, reviews and compilations, acquisition due-diligence investigations, consulting, and other agreed-upon procedures. Read more of Toby's accounting insights on our blog.

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