A new revenue recognition standard for GAAP companies

All companies in the US, mostly private companies that follow the U.S. Generally Accepted Accounting Principles, or GAAP, need to start implementing the new revenue recognition rules if they haven’t already.

Many companies did so in 2018, but many still haven’t, and the deadline for adoption of the new standard is fast approaching.

However, if you haven’t, the first thing that probably comes to mind is:

Are my accounting systems and staff ready for such a significant change in the manner that we perform our financial reporting?

If this is a question you might ask yourself, then you should read on, as we will talk, in greater detail, everything you should know about the change and how it will affect your company. All of that will be of importance to you because the effects of these changes are likely to be more encompassing than many have previously expected.

We are basing that on the feedback we’ve received from many companies that have already implemented these changes, most of them back in 2018, and they have thus had enough time to consider the effects of the new standard.

The implementation is as followed:

  • Public companies had to adopt the standard in 2018
  • Private companies have to approve it in 2019

Details about the changes

The Accounting Standards Update (ASU) 2014-09, or the Revenue From Contracts With Customers, is bringing about a fundamental change. The move will affect how companies report one of their most important indicators of financial performance.

That already shows that the effects of the ASU update will have huge implications. At the moment, GAAP is already complicated, it is:

  • Highly complex,
  • Very detailed, and
  • Disparate revenue recognition requirements

These have caused companies from different industries to start using separate accounting for very similar transactions, at least from an economic aspect.

Moreover, now, the updated standard is replacing most of these complex and industry-specific requirements that developed before 2014, with a unique and uniform model that’s also principle-based. Most companies will have to report their top line in income statements according to the new model.

The new, updated standard is not changing the underlying economics of:

  • Business transactions
  • When customers pay for goods or services

The new rules fundamentally change only the timing of when businesses can record the receipts from their customers which, depending on the company, can result in earlier or later revenue recognition.

The objective of this new model is to:

  • Rectify the weaknesses in existing requirements
  • Remove inconsistencies
  • Improve the comparability of revenue recognition practices for entities, jurisdictions, capital markets, and industries

Recognizing revenue under the new guidance

The new ASU standard is affecting how revenue from contracts is recognized. It will require the following steps:

  1. The company first needs to identify the agreement and the promises and performance obligations it has made under the said contract.
  2. Then the company must determine the price of the transaction. That needs to include the effects of all variable payments or other significant financing elements.
  3. The company is then under the responsibility to allocate the transaction price for the performance obligations it has under the contract.
  4. In the end, all that’s left for the company to do is to recognize the revenue when the previously mentioned performance obligations have been satisfied.

All in all, most professionals are expecting that the Accounting Standards Update 2014-09 will have a significant impact on companies that usually enter into long-term contracts with their customers. In essence, this means that the companies that will be most affected are:

  • Software providers
  • Other wireless providers
  • Construction firms
  • Media companies

On the other hand, some companies and other entities won’t even notice any significant change for their income statements.

However, almost everyone will notice the effect of the standard’s new expanded disclosure requirements. That’s because the new standard is requiring more disclosures to be made about the:

  • Nature,
  • Timing,
  • Amount, and
  • The uncertainty of the recognized revenues.

Why does this matter?

The deadline for the implementation of the new standard is drawing near, and that has vast implications for many businesses.

First of all, some private companies have still not familiarized themselves with the new rules that will affect them. That’s mostly because many companies usually underestimate the amount of work that’s involved with implementing new standards, especially the ones coming from the ASU 2014-09. If not that, they presume that the changes apply only to public companies and large private entities. That stems mostly from not having enough consultation with their finance and accounting teams.

However, ignoring these changes can hurt growing companies and their CEOs and executives. Even if these changes have a minimal effect on your business’ bottom line, it’s vital for you to evaluate all the controls and policies that are used to estimate revenues. It would be best if you did this before the year ends.

One of the main reasons for this lies in your loan covenants that can be affected by the changes. For that reason, you need to forewarn your lender as the changes to revenue recognition timing can affect the loan covenants.

If you undertake such proactive measures, you can even get some very positive outcomes. Being active in this issue can persuade your lenders to waive any violations made to the loan covenant, and they can ensure that the access to your credit is not interrupted.

The bottom line

All in all, your and any other growing company should not underestimate the scope of these changes. As you can see, some changes are small, but some have more important consequences which make revising the ASU 2014-09 vital.

If your business hasn’t started familiarizing with the new standard and the new revenue recognition guidance, you should begin doing so as soon as possible. The best thing you can do is to contact your accounting professional or hire new ones like Consero, who will ensure that a smooth transition takes place. Additionally, your accounting professionals will make sure they anticipate any adverse side effects for your company that can result from the new standard.

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