In May of 2014, the Financial Accounting Standards Board (“FASB”) issued its final standard on Revenue from Contracts with Customers known as Accounting Standards Codification (“ASC”) 606. Since the new standard was first introduced, the FASB has issued several Accounting Standard Updates to either amend or clarify the new guidance. The revenue standard has far-reaching implications for all industries as it eliminates industry-specific revenue recognition guidance under its predecessor standard, ASC 605.
The underlying principle of the new standard is that an entity should recognize revenue to depict the transfer of 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 order to recognize revenue ASC 606 introduces a 5 step model;
Identify the contract(s) with a customer
Identify the performance obligations in the contract
Determine the transaction price
Allocate the transaction price to the performance obligations in the contract
Recognize revenue when (or as) the entity satisfies a performance obligation
For private companies, the new standard is effective January 1, 2019, and the impact of adoption, as well as the new disclosures required, will need to be reflected in an entity’s financial statements for reporting periods after January 1, 2019.
In order to understand and quantify the implications of adopting the new standard an entity should consider the following questions;
How do we get paid? Is it at A Point in Time, for example, once a project is fully complete and transferred to the end customer, or do we get paid Over a Period of Time?
Who controls the asset that is ultimately being delivered as it is being constructed?
Is there a gap between when a bill for services, an asset, or a product is delivered to the customer and when the customer is required to pay for what was rendered?
What is your process for recognizing revenue on change orders, discounts, rebates, etc…?
Do you have a process for tracking and quantifying wasted materials or wasted labor?
Do you offer complimentary services for projects, such as design or engineering services which have traditionally been billed separately?
The answer to each of these questions will impact how revenue is recognized under the new standard. The above questions should be among the questions considered by companies as they begin to take an inventory of the various types of contracts they enter into as a part of their regular operations. Even if it is determined that the adoption of the new standard will not materially impact an entity’s financial statements, the entity is not absolved from the enhanced disclosures required by the new standard.
The technical information in this newsletter is necessarily brief. No final conclusion on these topics should be drawn without further review and consultation. Please be advised that, based on current IRS rules and standards, the advice contained herein is not intended to be used, nor can it be used, for the avoidance of any tax penalty assessed by the IRS.