Is your business equipped to handle the Financial Account Standards Board’s (FASB) new standards on revenue recognition? Private entities will have 2019 serve as the first fiscal year where these tax changes apply, so now is the time to learn how they affect your business! If you use contracts to receive revenue from your customers, then you’ll need to change how you recognize revenue from these transactions! We’ll cover the basics of FASB’s new standards on revenue recognition more below.
Why Did the FASB Change the Standard?
To understand the new standards, you’ll first need to know the purpose behind the change. Prior to the new standards, revenue from contracts was always a tricky tax subject because of the amount of unknown factors associated with it. The FASB indicates that the new standards were formulated with the purpose of clarifying the expectations for reporting revenue from contracts.
More importantly, the changes are intended to assist in making these revenue factors clear:
- Timing – When a business actually claims revenue from a contract.
- Value – How much revenue is reported from a contract.
- Uncertainty – Understanding the actual revenue of your business is difficult when you have outstanding contracts, considering you may have received payments without yet performing services.
In previous years, there have been several different requirements for recognizing revenue that made it hard to actually do correctly. This made it easy for errors and unnecessary audits to occur, which are now avoidable with clear expectations. Now that taxpayers understand exactly what they need to report (and when) for a contract, it will make it much easier to stay in compliance.
The new standards were actually announced in 2014 when the FASB collaborated with the International Accounting Standards Board (IASB). These two groups came together because methods for revenue recognition were previously quite different between Generally Accepted Accounting Principles (GAAP) used by FASB and International Financial Reporting Standards (IFRS) used by IASB. Under new standards, both GAAP and IFRS will now treat revenue from contracts the same.
What Does the New Standard Cover?
To make contract revenue recognition simple to understand, the FASB has established a core principle that a company should recognize revenue such that it reflects how much they expect to receive in consideration for the services and products they exchange. This principle alone doesn’t speak to when revenue should be recognized, but the FASB has also included five steps to use so that the core principle is honored:
- Identify Contract – The first thing you should do is determine when a contract actually begins.Classify
- Obligations – Then you’ll want to make sure you clarify what the performance obligations of the contract actually are. These are what a customer expects to receive in exchange for the payment they give you.
- Estimate Price – Once you know there is a contract and the obligations needed to honor it, you can now figure out the price for the contract. This can get fairly tricky if there is revenue tied to stipulations, but a price must still be determined.
- Apply Price to Obligations – As the performance obligations are a requirement for receiving the price of the contract, you’ll want to allocate the price to these performance obligations so you’re ready for the last step.
- Recognize Revenue in Alignment with Obligation Satisfaction – The final step in the process involves actually recognizing revenue. If there are multiple performance obligations, revenue can be recognized as they are completed. Otherwise, revenue should always be recognized when the (only) performance obligation is complete.
In addition to changing how you recognize revenue, you are now also responsible for providing several disclosures to provide customers with additional information. This will help promote transparency in contracts to allow both parties to fully understand the terms.
Are You Considering All Sources of Revenue?
These new standards for revenue recognition will apply to all forms of contracts. This includes contracts for transfers of services and products, but it also includes contracts concerning nonfinancial assets. Fortunately, this also comes with new standards depicting how a business accounts for costs to both acquire and complete a contract.
Something else you’ll want to consider is whether or not you have contracts with any applicable activities that may make the price of a contract unclear. With the new revenue recognition standards, you’ll be required to estimate several figures, especially for disclosure purposes. If you fail to take these special situations into consideration, then your estimates will likely be inaccurate.
Here are some of the most common contract situations you may encounter:
- Contracts with financing
- Loyalty programs
- Price discounts and/or incentives
- Multiple modifications
- License involved
- Option to purchase more and/or renew
Any contracts involving these scenarios end up having variable revenues. Any estimate you do make is difficult to accurately predict, but you should do your best to ensure you get as close as possible. Because many of these estimates are used for disclosures, there is additional pressure to ensure the accuracy of these figures to maintain transparency and integrity.
Professionals for Revenue Recognition
Both the FASB and the IASB collaborated to revise the standards used for revenue recognition. Previous standards differed between how GAAP and IFRS recognized revenue from contracts, but now both accounting bodies will treat it the same. This is done to help clarify the timing, price, and uncertainty of contract revenue. The FASB’s new standards include five important steps; identify a contract, determine the performance obligations, estimate the price, apply price to obligations, and allocate revenue as obligations are satisfied.
When you have a fairly simplistic contract, determining the amount of revenue you can expect to receive from it is fairly easy. Most contracts aren’t this simple though, instead they’re often filled with several contingencies and options that can alter how much revenue the contract generates. If you want expert guidance to ensure you’re recognizing revenue properly for 2019, then you’ll want to speak to an accountant at Evergreen CPAs! Send us a message today to see how we can help your business stay in compliance!