The Impact of Revenue Recognition Changes to Business Practice

FASB Changes Finances and Standard Operating Procedures

The Financial Accounting Standards Board (FASB) changed its revenue recognition standards for private companies in 2019. Previous to that, public companies experienced changes in 2018, even though the FASB created their new rules back in 2017. During all of these changes, the FASB introduced many new aspects that accountants needed to understand as they advised their clients. Those changes went beyond financial statements by also affecting standard operating procedures (SOPs).

It’s vital to understand these new revenue recognition standards. It’s equally as important to understand how they’ve impacted business practices in general.

The Official Changes Made to Revenue Recognition

The update to the revenue recognition standard issued in the spring of 2014 was listed as the Accounting Standards Update (ASU) 2014-09. Five final amendments arrived in 2016, which is where these new revenue recognition standards came from:

1. ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606) – Deferral of the Effective Date.
2. ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606) – Principal vs. Agent Considerations. Reporting Revenue Gross Versus Net.
3. ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606) – Identifying Performance Obligations and Licensing.
4. ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606) – Narrow-Scope Improvements and Practical Expedients.
5. ASU No. 2016-20, Technical Corrections and Improvements to (Topic 606) – Revenue from Contracts with Customers.

Revenue Recognition Standards Change Amount and Timing of Recognition

No two industries are the same, and SOPs can vary greatly within each industry. Yet, the new standard paints every sector of the economy with a broad brush. This means uniform accounting practices now apply to areas that have traditionally followed very different guidelines. This new approach puts a greater emphasis on more details, judgments and disclosures.

Existing revenue recognition guidance lacks consistency across industries and fails to address certain types of arrangements. One example of this is gross revenue versus net revenue for principal or agent consideration. This new standard aims at improving comparability and eliminating gaps in guidance.

Depending on an entity’s existing business model and revenue recognition practices, the new standard has an impact on the amount and timing of revenue recognition. It changed key performance measures and debt covenant ratios. Ultimately, it could also affect contract negotiations, business activities and budgets.

A Burden on Managers and Bookkeepers Alike

As a result, chief executives and CFOs must reassess the way they run their companies and make changes to the middle management and point-of-sale levels. These situations could affect wide-reaching areas related to ongoing resource management, business processes, or policies and current IT infrastructure.

One change in particular relates to the practice of inventory management. Previously companies used one line item within the financial statements to disclose a company’s stockpile of goods. Now, the companies must break inventory out into much greater detail. A great example of this is if products sold have associated rights of return. The estimated inventory expected to be returned will have to be disclosed as a separate line item from the regular inventory.

Disclosures Drastically Reshape Financial Statements

The new revenue recognition standards mentioned above drastically reshape a company’s financial statements. There are more assets, liabilities and disclosures to weigh and consider. It presents an enormous challenge for the auditors charged with reviewing this information. Nonetheless, this is an important job. It’s especially important for loan officers or venture capitalists. Knowing this type of data will give a clearer picture of the nature, amount, timing and uncertainty of the revenue that companies have with their customers. This data could also alter the valuation of the underlying business or impact the amount borrowed.

Given the significant changes in the recent years, adequate training and education are an important element for companies to consider. That could mean increasing staffing with more CPAs or investing in employee education or advanced information technology.

CPAs should guide this preparation process. We call it STEP: Study, Evaluate, Prepare.

Best Practices: How to Use S.T.E.P

Study

The first phase involves learning everything you can about the new revenue recognition standards and their background.

Financial statement preparers and auditors must learn the details of the new standard and the amendments that occurred since the new standard arrived in 2014. They also must understand the transition methods available upon adoption and review the new disclosure requirements.

More importantly, companies that used the older standards should get a clear understanding of how the new standard differs compared to current practice. Getting a 10-minute overview of the standards is not enough.

Evaluate

The second phase: Any changes that happened with the new updates with an operational or financial impact should be evaluated. This includes identifying the key revenue streams and contracts, reviewing the business’ current accounting policies and how they compare to the new standards, as well as communicating these analyses with various internal (such as upper management) and external stakeholders (such as shareholders and bankers).

Prepare

The last phase: Once everyone is on board, the preparation for adoption of the new standards begins. An essential step for this is establishing detailed timelines to execute any changes required as a result of the new standards. New accounting policies and procedures may have to be developed or, at the very least, existing ones will have to be modified.

Revenue Recognition Is a Team Effort

Even some of the more subtle changes require full top-down changes at an organization. This will include the cooperation of everyone, from lower-level employees to C-suite executives. Some don’t think the changes will affect them. But they might want to remember that their bonuses may shrink if revenue is the major driver in the calculation.

[Editor’s Note: To learn more about this and related topics, you may want to attend the following webinars: Buying & Selling IP and An Introduction to a New Yet Old Funding Alternative 2019. This is an updated version of an article that was published on February 9, 2017.]