The revenue recognition guidelines under ASU 2014-09, Revenue from Contracts with Customers, replace nearly 180 pieces of industry-specific guidance in GAAP with a broad, principles-based method for most businesses to recognize revenue. (See “5 Steps to Recognize Revenue,” below.) This approach to revenue recognition is more closely aligned with international financial reporting rules.
The changes will be significant, especially for manufacturers and distributors who enter into specialized, long-term contracts with customers. For some companies, the updated guidance will result in earlier revenue recognition or delayed revenue recognition compared to current practice. One reason this could occur is that the standard will require companies to estimate the effects of items such as sales incentives, discounts and warranties. The standard also provides guidance on service revenue and contract modifications.
Nearly all manufacturers and distributors will need to beef up their footnote disclosures under the standard. The update requires detailed breakdowns of revenue by product lines, geographic markets, contract length, services and physical goods.
The revenue recognition guidance went into effect for public companies in 2018 and private companies in 2019.
Proactive manufacturers who have started the implementation process forewarn of the challenges. Christine DiFabio, assistant controller at Zoetis, a manufacturer of animal medicines, said during a panel discussion at Financial Executives International’s Current Financial Reporting Issues Conference, “For those people who haven’t started or are very early [along], try to start to speed it up, because while you may not think it will have a significant impact financially, it’s a significant impact in workload — and documentation efforts as well.” She described the accounting change as “all encompassing.”
Michael Cleary, Boeing vice president of accounting and financial reporting, also acknowledged during the panel discussion that the changes under ASU 2014-09 would significantly alter when his company records revenue. Boeing’s customer contracts are typically long-term and complicated, so he formed a steering team, including officials from the communications and human resource departments, tasked solely with implementing the standard.
5 Steps to Recognize Revenue
Accounting Standards Update (ASU) No. 2014-09 will require companies to follow five steps when deciding how and when to recognize revenue:
Understanding Your Contracts with Customers
One of the most critical aspects of the standard requires companies to gain an understanding of their contracts with the customer for providing goods and services. Revenue is recognized to depict the transfer of the promised goods or services that will reflect the total consideration to which the entity expects to receive.
Under the standard, a contract is an agreement between two or more parties that creates enforceable rights and obligations. A contract with a customer exists when all of the following criteria are met:
There are many aspects of the contract that can affect the amount of revenue recognized or even when revenue is recognized. The following are some items that could have an impact:
As companies continue to navigate the implementation of this standard, below are some steps that can help along the way:
Compared to prior GAAP, the updated guidance will require companies to exercise greater judgment when recognizing revenue. VonLehman’s revenue recognition experts can help you make informed decisions based on the terms of your customer contracts. Be on the lookout in the coming weeks as we continue to update manufacturing and distribution companies on all things revenue recognition.