Overhaul of Revenue Recognition Standard Will Impact Your Organization

David Thorp, Principal, Assurance, CliftonLarsonAllen LLP

In May 2014 the Financial Accounting Standards Board (FASB) issued new accounting standards that revamp the rules for revenue recognition. FASB completely rewrote the rules, creating a new framework to be applied in determining when and how an entity recognizes revenue in its customer contracts. Although no further formal guidance is expected soon, accounting professional and several trade associations have begun studying specific issues unique to various industries. The effective dates for these new rules (which have been pushed back one year due to implementation issues) are currently for years beginning after December 15, 2017 (for public entities), and after December 15, 2018 (for all other entities).

New framework based on core principle

As a part of the new rules, FASB established a core principle for recognizing revenue, which essentially means that revenue should only be recorded when you transfer the goods to your customer at the price you agreed to.

FASB also included five steps to achieve this core principle before an organization can determine how to recognize revenue from customers:

Step 1: Identify the contract(s) with a 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 obligations in the contract.

Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.

Implementation challenges

At first glance, the new rules do not appear to be overly complex. However, some implementation issues will be challenging.

Most entities have a variety of contractual arrangements with customers, to provide products and services (performance obligations). The countless ways that entities are paid for these products and services (the transaction price) may make implementation a little confusing.

The biggest impact of the new rules will be primarily on transactions that straddle the end of the reporting period (typically year-end), therefore, organizations should focus their efforts on the revenue recognition issues related to those transactions.

Variations by industry

Several industry groups have explored the new rules and identified issues specific to their businesses.

Auto dealers

New car sales contracts contain more than one product or service in addition to the sale of the car (i.e., service contracts, life-time oil changes or car washes, warranty agreements). Are these separate performance obligations or not? These products or services are provided at different times, so it is difficult to determine when the performance obligation has been satisfied. Also, the price paid for these services is not always known at the date the sale is made, so how and when is the transaction price determined?

Construction industry

In the construction and real estate industries, contractors often enter in to multiple contracts with the same customer. Can these contracts be considered one contract, or does each contract need to be accounted for separately? Contracts also contain multiple deliverables such as buildings, roads, infrastructure or framing, sheet rocking, or painting. Can these different performance obligations be considered one continuous performance obligation satisfied over time or should they be treated as separate performance obligations? Home builders sometimes build their homes on land they own and other times on the customer’s land. At what point is the performance obligation satisfied in various homebuilding scenarios?

Nonprofit organizations

While contributions (a source of revenue for many organizations) are exempt from the new standard, nonprofit organizations should still pay attention to the new rules. For example, some transactions (i.e., special events or corporate sponsorships) may be part contribution and part exchange transaction. Other transactions may involve non-monetary assets or liabilities (reciprocal exchanges) that fall under the new rules.

In addition to the issues mentioned above, nonprofits often have contacts with state and federal governmental agencies. Are these agencies considered customers under the new rules?

Colleges and schools collect tuition and fee income, but which are performance obligations (i.e., classes, books, extracurricular programs) and do they need to be accounted for separately? At what point are the performance obligations satisfied?

For membership organizations that collect dues, what services are provided in exchange for these dues and do they need to be accounted for separately? What about lifetime memberships? Over what period are the performance obligations satisfied?

Health care organizations

From hospitals to continuing care retirement communities (CCRCs), the new revenue recognition model will have an impact. A variety of settings will be affected in the health care industry due to the huge range of financial transactions. Hospitals that provide emergency services to uninsured or self-pay patients will have to determine what constitutes a contract and when the transaction price is determined. And when hospitals group their contracts separately between uninsured or Medicaid patients or by facility, should they be treated as separate contracts under the standard?

Financial services and banking organizations

It is unclear when the performance obligation is satisfied for broker dealers who collect commissions from the sale of securities. Is it the trade date or the settlement date? Similarly, for financial planners who collect asset management fees, is the performance obligation met in the interim period or at the end of the contract period?

Retail industry

Retailers often have a return policy with their customers. How does this policy impact the satisfaction of the performance obligation and the timing of revenue recognition? Some retailers also have loyalty programs (reward cards or points systems.) Are these separate performance obligations? How is the transaction price determined?