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Private Companies Face Deadline for New Revenue Recognition Standard

A critical deadline is approaching for private companies. For annual reporting periods beginning after Dec. 15, 2018, private entities must adopt a new standard for revenue recognition issued by the Financial Accounting Standards Board (FASB).

The new standard, “Revenue from Contracts with Customers,” replaces all previously existing standards and guidance in order to, among other things:

  • Improve consistency and eliminate weaknesses in standards across industries, in coordination with international standard setters
  • Improve the overall revenue recognition framework and user utility of disclosures
  • Simplify financial statement preparation through the condensing and elimination of a wide array of various standards that historically had to be considered

The FASB establishes financial accounting and reporting standards for entities that follow accounting principles generally accepted in the United States (“US GAAP”).

Now that private company adoption is nearly upon us, how ready is the marketplace?

Don’t Delay

While “don’t delay” is advice that may have been more helpful eight to 12 months ago, depending on the nature of your business, there is still time to adjust.

Let’s assume for the moment that upon adoption, the new standards will significantly impact the amount and timing of revenue recognition and the related disclosures. Further, let’s suppose that your company has a high volume of revenue transactions and has historically issued comparative financial statements and wants to continue to do so. Finally, let’s assume that your accounting system is outdated and not easily adaptable to changes in automating the manner in which transactions are recorded.

If any of these assumptions applies to your company, it may place undue stress on it as you attempt to manually manipulate two years of high-volume transactions to reflect the new model in comparative financial statements. Your senior financial executives will have little time to focus on high-level strategic management should they have to scramble to convert systems and processes to comply with the ongoing accounting under the new standard.

Even if you have delayed the process to this point, there are steps you can take now to avoid a fire drill and execute change as a managed process.

Before we get into recommended steps to take before the effective date, let’s cover the basics of the new rules that will inform what actions will be necessary.

Standard in Summary

The new revenue recognition standards require an entity to apply five revenue recognition steps. The standard wants revenue recognition to be more transparent throughout the history of transactions, by:

  • Identifying contracts with the customer
  • Identifying the performance obligations in contracts
  • Determining the transaction price
  • Allocating the transaction price to the performance obligations in contracts
  • Recognizing revenue when the entity satisfies a performance obligation

While this summarizes the standard, there are nuances within the standard and multiple implementation guidance resources that require much greater scrutiny than simply applying the five-step recognition process.

In keeping with the theme of the standards, a five-step implementation process is suggested as:

  • Learn the standards
  • Perform and document an internal assessment
  • Develop and document an action plan
  • Communicate with applicable persons
  • Implement the plan

What does each of these steps entail?

Learn the Standards

This step should incorporate reading the actual standards, the FASB’s Transition Resource Group publications and the AICPA’s Industry Task Force guides, among other reputable published resources. It should involve looking at comparative public companies for guidance. They have already implemented the standards, so their experience should prove valuable. Finally, it should include discussions with your professional accounting service providers.

Perform and Document an Internal Assessment

Once you have a basic working knowledge of the standards, you should be reasonably well-positioned to perform an internal assessment. That assessment should start with determining the extent of applicability.

If the initial assessment is that it has little applicability, the assessment should be documented along with a plan for addressing any minor applicable items—there are likely to be some. This should be shared with your accounting professionals to gain buy-in to the assessment and ensure you’re not missing anything before concluding the initial internal assessment. Buy-in among various parties is key as the new standard shifts from a rules-based approach to accounting for revenue to a principles-based approach that requires much more discernment.

Should the initial internal assessment show it’s highly likely that there will be significant changes in revenue recognition and related disclosures, you’ll need to dig deeper in your internal assessment in addition to the documentation, communication and buy-in indicated above. Your internal assessment in this situation will also need to include an assessment of personnel and accounting system resources, as well as the needs of financial statement users. You’ll want to assess:

  • How you currently process data
  • How you may need to process data going forward
  • Whether your resources can handle the transition

In performing your initial extent of applicability analysis, you will want to think through the complexity of your business and revenue cycle. For example, if you buy and sell screws for fixed prices without customer incentive, discounts or other charges, you may conclude that your cycle is not complex and therefore will not result in an accounting change other than perhaps enhancement of disclosures.

On the flip side, a company with multiple performance obligations, across various types of contracts, will need to apply judgment to determine revenue recognition for each type of contract. Construction contractors, health care, hospitality and software are just a handful of examples for which AICPA Task Forces have been formed to assist in transition, as they often involve more complexity in their customer contracts.

Develop and Document an Action Plan

The assessment should lay the foundation for an action plan, including who should be involved. Using this, you can develop a timeline and assign responsibilities. Special care should be taken to determine the data and processes needed. Why? You don’t want to get to the end of 2019 and determine that you need different data than your system generated all year.

You will also want to consider human resource needs in your action plan. You may be confident that your internal team can accomplish this task, but other important strategic matters may fall by the wayside while it’s doing so. Whatever decisions are made should be incorporated into a documented action plan for tracking and accountability.

Communicate with Applicable Persons

Presumably various staffers have been involved in parts of the preceding phases. However, upon completion of the plan, it should be shared with all relevant internal staff, including assigned responsibilities and deadlines. Again, your professional accounting services provider should also be brought up to speed on the plan, including anything you want it to assess prior to making major overhauls.

Finally, bankers, board members, investors, executives and other interested parties should be apprised of significant changes that may come from this undertaking. Having these discussions concurrent with executing the plan should allow time to revise agreements for covenants, bonus arrangements or other matters as needed—as opposed to awaiting issuance of the financial statements and dealing with issues that arise in the aftermath. You don’t want to be in a position of failing covenants or having to pay out additional bonuses or other monies due to a mandated accounting change.

Implement the Plan

The knowledge has been gained, the assessment completed, the plan formed and communicated. Now, you only need to execute. This is where most plans fail. Simply put, in order for the plan to succeed, responsibilities must be assigned, with deadlines. Further, some element of accountability should be included that highlights shortcomings. Finally, assign a plan champion to orchestrate and keep everyone on plan.

If you have done all of this, you will reduce the risk of starting off 2019 by entering into and recording revenue transactions in a manner not in accordance with the new standard. Furthermore, your employees can execute the transition without any last-minute scrambles, while minimizing distraction from where you need them most on a recurring basis.