Many contracts between a seller and a buyer could be essentially comprised of smaller subcomponents and it needs to be taken into consideration
In 2014, the Financial Accounting Standards Board (FASB) released Accounting Standards Update (ASU) 2014-09: Revenue from Contracts with Customers, which addresses the assumption that many contracts between a seller and a buyer could be essentially comprised of smaller subcomponents and it needs to be taken into consideration whether or not these subcomponents can be defined as separate performance obligations. The outcome from these considerations could dictate the timing of when revenue is recognized on the contract. The FASB’s focus here is to better achieve a matching between the timing of services performed under these contracts and the timing of revenue recognized. This will enhance the usefulness of the information within the financial statements and provide for greater comparability across entities. ASU 2014-19 is effective for non-public companies with fiscal years beginning after December 15, 2018 (i.e. – effective for 2019 calendar year-ends and 2020 fiscal year-ends).
The five-step process:
At the core of ASU 2014-09 is a five-step process to achieve proper recognition.
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 as the company satisfies a performance obligation
When a company goes through the above exercise with some of their existing contracts it could be an eye-opening experience. What they may determine is that based on the timing of the performance obligations being met, revenue may have been recognized in the improper period.
What are the most important takeaways for companies?
- Get familiar enough with ASU 2014-09 from 5,000 feet. Consult your CPA.
- Take a look at your contracts, especially those that are larger and span multiple years.
- Increase the time and effort put into tracking the contract performance obligations being met.
- Realize that there are potential balance sheet implications (which could impact debt covenants).
- Recognition of a liability (cash received in advance of performance obligation being met)
- Recognition of an asset (receivable for performance obligations met but not billed)
Contact Us With Your Questions
If you have questions about the new revenue standards, contact our accounting professionals at The Innovative CPA Group at 203-489-0612. Or contact us online.