As most of the planet knows, at least all of the accountants that have not been living under a rock, the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) issued a new revenue recognition standard in June 2014 that will supersede the existing revenue guidance in US GAAP and IFRS. Under US GAAP this standard was issued as Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606).
One of the most often asked questions that we receive is why did the FASB issue new guidance on revenue and what was wrong with the existing guidance? These are very good questions that have no easy answers as a lot of stakeholders were asking the FASB these very same questions during the 10 year journey of working multiple rounds of exposure drafts and comment periods from a diverse group of stakeholders.
The FASB stated that one of the reasons for issuing the new revenue standard is that US GAAP differs from IFRS and both sets of standards could use improvement. Previous revenue recognition guidance under US GAAP comprised broad revenue recognition concepts together with numerous revenue requirements for particular industries or transactions, which sometimes resulted in different accounting conclusions for similarly economically situated transactions. Therefore, the FASB sought to accomplish the following by issuing ASU 2014-09:
- Remove inconsistencies and weaknesses in revenue requirements.
- Provide a more robust framework for addressing revenue issues.
- Improve comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets.
- Provide more useful information to users of financial statements through improved disclosure requirements.
- Simplify the preparation of financial statements by reducing the number of requirements to which an entity must refer.
As indicated by the above items, the FASB wanted all companies regardless of industry to apply a single revenue standard, which would increase comparability among entities. It should also be noted this is the first true principles based standard issued by the FASB. As such, the new revenue standard will introduce a lot more judgment into recognizing revenue as compared to the existing rules based guidance. Time will tell if the standard will actually accomplish all of these lofty goals.
The core principle of the guidance is the entity should recognize revenue 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. To achieve this core principle, the new standard outlines a five step model or framework that entities should use when applying the principles in this standard:
- Identify the contract(s) with a customer.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations in the contract.
- Recognize revenue when (or as) the entity satisfies a performance obligation.
The new guidance must be adopted using either a full retrospective approach for all periods presented in the period of adoption (with some limited relief provided) or a modified retrospective approach. The required effective date is fiscal years beginning after December 15, 2017 for public entities or December 15, 2018 for nonpublic entities. All entities may early adopt the standard for fiscal years beginning after December 15, 2016.
Over the next several months we will dive into each of these five steps along with the effective date and transition methods. We will concentrate on some of the more interesting and challenging aspects to the new standard and how it might impact certain companies that currently follow industry guidance.
I look forward to having you along for this journey through ASC 2014-09.
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