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Revenue recognition changes, like this business using credit cards, impacts business practices

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. Before that, public companies experienced changes in 2018, even though the FASB created its new rules in 2017. Through these changes, the FASB introduced many new aspects that accountants needed to understand as they advised their clients. Those changes went beyond financial statements and affected standard operating procedures (SOPs).

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

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.

Subsequent FASB updates addressing revenue from contracts with customers, Updates 2019-08, 2020-05, and 2021-02 address guidance related to share-based considerations and topics explicitly related to franchisors.

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.

Improved Comparability and Continuity

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

Effects of Updates to Revenue Recognition Practices

Depending on an entity’s existing business model and revenue recognition practices, the new standard impacts 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 how 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, policies, and current IT infrastructure.

Changes to Inventory Management

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 must 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 crucial for loan officers or venture capitalists. Knowing this type of data will give a clearer picture of the nature, amount, timing, and uncertainty of companies’ revenue with their customers. This data could also alter the valuation of the underlying business or impact the amount borrowed.

New Standards Call for New Training

Given the significant changes in recent years, adequate training and education are essential for companies to consider. That could mean increasing staffing with more CPAs, 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 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 use the older standards should clearly understand how the new standard differs from current practice. Getting a 10-minute overview of the standards is not enough.

Evaluate

The second phase: Any changes from the new updates with an operational or financial impact should be evaluated. This includes identifying the key revenue streams and contracts, reviewing the business’s current accounting policies and how they compare to the new standards, and 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 is establishing detailed timelines to execute any changes required due to the new standards. New accounting policies and procedures may have to be developed, or, at the very least, existing ones must be modified.

Revenue Recognition Is a Team Effort

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


We think you’ll also like:

  1. Know Thy Numbers Installment #2—Accounting Principles in a Nutshell 
  2. Know Thy Numbers’ Installment #7—Accrued Expenses

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

  1. Corporate & Regulatory Compliance Boot Camp: Part 2 
  2. Valuing Your Brand and Other “Soft” Assets 
  3. Trade Finance Basics  

This is an updated version of an article originally published on February 7, 2017, and revised on February 27, 2020.]

©2023. DailyDACTM, LLC d/b/a/ Financial PoiseTM. This article is subject to the disclaimers found here.

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About Hogiadi (Hogi) Kurniawan

Hogiadi (Hogi) Kurniawan, CPA, is a senior manager in the Audit and Business Advisory Services Department at Haskell & White LLP, one of the largest independently owned accounting, auditing and tax consulting firms in Southern California. Previously, Hogi was an audit manager for a Big Four firm and an audit manager for over eight years…

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