Revenue is one of the most important factors used to assess an entity’s financial performance and position. But, previous revenue recognition requirements weren’t standardized throughout the U.S. or the world, causing some inconsistencies and application problems across industries, transactions, and geographies.
The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) worked together to converge their respective revenue recognition standards. As a result, FASB issued “Revenue from Contracts with Customers (Topic 606).”
Key changes in the revenue recognition standard
This standard aims to remove inconsistencies, provide a framework to better address revenue issues, and improve the comparability of revenue recognition practices across entities, industries, and transactions.
In addition, the guidance hopes to improve disclosure requirements and simplify the preparation of financial statements by condensing revenue recognition into a single standard.
The updated standard may affect any entity that enters into contracts with customers to transfer goods, services, or nonfinancial assets. It’s effective for public entities with annual reporting periods beginning after December 15, 2017 and nonpublic entities with annual reporting periods beginning after December 15, 2018.
For nonpublic entities, an implementation plan for these standards should be in place at the start of the entity’s fiscal year – January 1, 2019 for entities with a December 31 year-end.
To prepare for the new revenue recognition standard, follow these steps.
- Analyze your revenue streams to determine which stream(s) the new standard will impact most.
- Run revenue stream(s) through the five step model to determine if a material accounting adjustment is required.
Once you’ve fully analyzed your business’ revenue streams, you’ll need to apply a beginning-of-year adjustment.
Apply an adjustment
A beginning-of-year adjustment must be made to the earliest reporting period presented in your financial statements. You can select two options to perform this adjustment – the full retrospective approach and the modified retrospective approach.
The full retrospective approach requires each reporting period presented in the financial statements to be prepared using the new standards. For comparative December 31, 2019 and 2018 financial statements, you should adjust the years presented to comply with the new standards. You should also adjust December 31, 2017 to properly report the beginning of the year equity balance as of January 1, 2018.
The modified retrospective approach only presents a single year financial statement. For a single year December 31, 2019 financial statement, you should only adjust two years to comply with the new standard – the year presented and a cumulative prior year adjustment to properly report beginning of the year equity.
Analyzing revenue streams and determining changes to revenue recognition now will help you make any necessary adjustments for financial reporting in accordance with generally accepted accounting principles (GAAP) in 2019.
The five step process will likely present challenges. And, it will require a thorough analysis of contract terms and decisions on how to recognize revenue. Make sure your implementation plan is in place by the start of your fiscal year to avoid any last minute challenges.
Have questions about the new revenue recognition standard? Let’s talk!