Changes in Revenue Recognition for the Technology Industry
For several years, FASB has undertaken the task of developing a new ASU (Accounting Standards Update) that would create more consistency in the application of revenue recognition amongst a wide variety of industries as well as converging US GAAP (Generally Accepted Accounting Principles) with IFRS (International Financial Reporting Standards). In 2014 a huge step in that direction was made when the FASB issued ASU 2014-09, Revenue from Contracts with Customers.
When is ASU 2014-09 effective?
Consistent with previously issued significant ASU’s, privately held companies are given a fair amount of time to consider the changes and implement, accordingly, this ASU is effective for annual reporting periods beginning on or after December 15, 2017, and interim reporting periods within annual reporting periods beginning after December 15, 2018. Private entities may elect to adopt early however no earlier than public entities. Public entities are required to adopt the standard in reporting periods beginning after December 15, 2016.
How does this impact the technology industry?
The accounting community seems to have largely agreed that the standard promotes more subjectivity (as a “principles-based” standard) and use of estimates when considering revenue recognition and establishes the following core principle: recognize revenue to depict the transfer of goods or services to customers (where by the customer obtains “control”) in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
The seller must both evaluate the customers’ ability and intent to pay the stated price. This requires an upgrade from looking purely at the contractual price to also building in the seller’s expectation of payment. Further, the seller must identify all distinct elements of a contract (as individual performance obligations) and value them, even if certain elements are implied rather than explicitly stated. An example of this is offering unusual payment terms within a contract that by themselves can have value for the buyer. This is important as it can change the way multiple element contracts are reviewed and value is allocated. It could also change the timing of revenue recognition as one allocates value to “implied performance obligations”. Importantly, revenue is recognized when these performance obligations are satisfied by the customer obtaining “control” (the ability to direct the use and benefit from the product). This replaces the current focus on recognizing revenue when risks and rewards are transferred.
What this fundamentally means is that performance obligations within a contract need to be carefully identified and the transaction price for that contract needs to be evaluated not as a dollar value stated in the document but as expected future cash flows. The potential for identifying more performance obligations exists.
While the literature may not come across as radically different from how we account for revenue now, applying the concepts of “distinct performance obligations” and “expected consideration” may produce different outcomes than current practice and could result in revenue being recognized more expeditiously under the new guidance when compared to current practice.
Other issues the standard addresses, clarifies and modifies include how companies should account for contract modifications, gross vs. net presentation of revenue as well as the need for Companies to accrue for and place value on expected rights of return and expected reimbursement from vendors. In addition, the standard will require entities to capitalize incremental costs of obtaining a contract (typically fees and sales commissions) which today are typically costs that are expensed as incurred.
This “principles-based” approach will result in a substantial amount of additional judgment when implementing revenue recognition policies. This in turn triggers what we expect to be significantly expanded disclosures of a Company’s revenue recognition policies including certain quantitative information.
How does our Company respond to this new standard?
This new ASU is robust and addresses many different nuances within revenue recognition. This article is meant only to give you a brief introduction to those concepts and therefore we always recommend that you speak to your accountants and advisors about the standard and specific issues that impact your Company and revenue lines. In addition, the full version of the ASU is available on the FASB website for review and analysis (www.fasb.org).
Generally the first step in implementing any new guidance is to start by identifying the key changes that impact your business. Sweeping standards such as this one can be overwhelming at first. However, when you get under the hood, it is possible that 80%+/- of the changes are not applicable to your Company at all. So obtaining an understanding of the key points is important, and honing in on the parts that are relevant to you is critical. We recommend applying the new standard to a few representative contracts off-line, on a step by step basis, to highlight areas of differences from present accounting.
Once you have a good handle on the areas of importance to your Company, it is critical that those involved in revenue generation (shareholders, business development/sales team and finance) fully understand the facts and collaborate on your business strategy going forward. Formulating a plan prior to implementation is fundamental to success.
Finally I cannot overstate the importance of staying on top of new developments. It’s not uncommon for implementation timelines to change and/or be delayed. Also, implementation guidance as well as interpretations often follows new standards to help give the accounting community a road map. With that in mind, again, be sure to frequently keep in touch with your professionals who monitor changes such as these constantly.
