Revenue Recognition – A Change in Professional Standards
ASU 2014-09 Revenue from Contracts with Customers (Topic 606)
The new revenue recognition standards are effective for annual reporting periods beginning after December 15, 2017 for public entities and for annual reporting periods beginning after December 15, 2018 for non-public entities. The new guidance defines revenue recognition as to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
There are five steps to follow to recognize revenue under the new standard.
1. Identify the contract(s) with a customer (applies to a contract if all the following criteria are met)
-Approval and commitment of the parties
-Identification of the rights of the parties
-Identification of the payment terms
-The contract has commercial substance
-It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer
If the criteria is not met, the entity is precluded from recognizing revenue under the contract until all performance obligations have been satisfied and promised consideration is received.
2. Identify the performance obligations (performance obligation is a promise in a contract with a customer to transfer to the customer)
-A good or service or a bundle of goods or services that is distinct or
-A series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer
-Distinct good or services are accounted for separately (i.e., they are separate performance obligations)
3. Determine the transaction price
-Transaction price is the amount of consideration to which the entity expects to be entitled
-It can be a fixed amount or included variable consideration
-Estimating variable consideration will require a significant amount of judgment
-An amount of consideration can vary because of discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties, etc.
-Estimate the variable consideration based on the 1) expected value or 2) most likely amount 3) whichever is most predictive of the amount to which the entity will be entitled
-Constraint is that it is probable that the subsequent changes in the estimate would not result in a significant reversal of revenue
-Other factors to consider in determining the price is significant financing, non-cash consideration and consideration payable to the customer
4. Allocate the transaction price to the performance obligations
-Allocate the transaction price to each performance obligation on the basis of stand-alone selling price
-Use an observable price or estimate using an approach that maximizes observable inputs (adjusted market assessment, expected cost plus margin or a residual approach)
5. Recognize revenue when (or as) performance obligations are satisfied
-Performance obligation is satisfied when the customer obtains control of the good or service
-Control is the ability to direct the use of, and obtain substantially all of the remaining benefits form the asset
-Control can transfer over time or at a point in time
Revenue recognition is going to require much more estimating under the new standards than under the current standard of revenue recognition. There will not be any allowance for doubtful accounts and collectability will need to be reflected in the revenue recorded at the time the revenue is recognized.