Is your business a private company? Or a nonprofit? Does your fiscal year start on or after Oct. 1? If you answered yes, you should have the new revenue recognition standard – Topic 606 – on your mind.
The new standard is live and in effect for many companies now.
But, if your fiscal year starts on or after Oct. 1, the standard hasn’t taken effect yet. It’ll go into effect when you begin your 2019 fiscal year.
If your 2019 fiscal year already started – say on March 1, 2019 – you should have already implemented the new standard and should be actively following it. If you haven’t, it’s not too late.
You can still figure out if you need to make any changes and do so by the end of your fiscal year – in time for your financial statement audit, review, or compilation. If your fiscal year-end is Dec. 31 and you haven’t reviewed how the standard applies to your business, you should look into it as soon as possible. You should make any financial adjustments before your year-end arrives.
The new standard is officially known as Accounting Standards Codification (ASC) 606: Revenue from Contracts with Customers. The Financial Accounting Standards Board (FASB) also issued ASC 340-40: Other Assets and Deferred Costs – Contracts with Customers. Collectively, we refer to them as Topic 606.
Together, these standards present a principles-based approach for recognizing revenue instead of an industry-specific approach. Essentially, FASB issued this guidance to streamline how all businesses and nonprofits recognize their revenue – no matter their industry. However, lease revenue and contribution revenue for nonprofits aren’t subject to this standard.
Topic 606 creates a five-step process on how all businesses should recognize revenue. The five steps are:
- Identify the contract(s) with your customer
- Identify distinct performance obligations within the contract
- Determine the transaction price
- Allocate the transaction price to distinct performance obligations
- Recognize revenue over time or at a point in time
If you’d like a more detailed look at each of these steps, read The 5 Step Approach to Revenue Recognition.
Though these steps seem simple enough, there are many intricacies woven into the standard. You need to know the details to understand the impact on your business.
For example, what costs go into obtaining a contract? If you combine contracts, how does that impact how you recognize the revenue for each? Does your pricing rely on fixed consideration or variable consideration? If your contracts include variable consideration, how do you estimate the amount you’re entitled to receive?
Run through these steps to see how your business might be affected. It’ll reveal whether you need to make any policy elections or changes to comply with the new guidance.
If you’re subject to an annual financial statement audit…
Your auditors may perform procedures to test how you’ve applied the five-step model against your significant revenue streams. It’s important to develop policies and internal controls within your organization to ensure you’re complying with Topic 606.
Implementing the following internal controls is a good place to start:
- Create a master list of all material categories or contracts with customers. Your accounting staff should maintain the list, review it regularly, and update it.
- Analyze and review all contracts (or classes of contracts) to identify distinct performance obligations.
- Review contracts with customers to verify the amount of consideration you expect to receive in each material transaction (or class) when transferring promised goods or services.
- Analyze and review contracts with customers to ensure proper allocation of the transaction price to each performance obligation in proportion to standalone selling prices of the promised goods or services.
- Monitor the recognition of revenue based on the transfer of control of a promised good or service to the customer.
- Review and reconcile contract balances and revenue recognized to the underlying general ledger accounts.
If you aren’t subject to a financial statement audit, you’re not off the hook. You must apply the new standard to all financial statements issued under generally accepted accounting principles (GAAP).
Plus, you’re required to provide enhanced disclosures for audits, reviews, and full-disclosure compilations, so it’s best to have a thorough understanding of the new standard. Get to know how the five-step model applies to your significant revenue streams.
If you need assistance understanding and implementing the standard, contact us. We can break down the standard with you, show you how it applies to your business, and help prepare you for a smooth transition. No matter your fiscal year-end date, you’ll want to ensure you’re complying with the new standard before your audit begins.
If you’re already practicing the new revenue recognition standard and want accounting experts to review how you’re applying the standard, we can do that too.
Have questions about Topic 606 and recognizing revenue? Let’s talk!