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Manufacturers and Distributors: Act Now on Adoption of New Revenue Recognition Standards
Revenue is one of the most important measures used to assess a company’s performance. Recognizing the need for improving how companies measure and report revenue, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) spent many years working together on a converged standard to replace the accounting guidance for revenue recognition, with several objectives, including:
- Removing inconsistencies and weaknesses in existing revenue requirements
- Providing a more robust framework for addressing revenue recognition issues
- Improving comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets
- Providing more useful information to users of financial statements through improved disclosure requirements
- Simplifying the preparation of financial statements by reducing the number of requirements to which entities must refer
In May 2014, the two standard setters issued converging guidance on revenue in contracts with customers. In the U.S., the FASB issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). The IASB’s standard was issued as IFRS 15.
Superseding virtually all revenue recognition requirements in IFRS and U.S. GAAP, the new revenue recognition standard establishes an underlying core principle under which an entity recognizes 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. The standard establishes a five-step framework that entities will be required to apply in order to achieve the core principle described above:
- Identify the contract(s) with a customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocated the transaction price to the performance obligations in the contract
- Recognize revenue when (or as) the entity satisfies the performance obligation
Each of the steps in the five-step framework can impact the amount and the timing of revenue recognized. The potential impacts can vary significantly among entities. Manufacturers and distributors that manufacture and sell products through simple distribution channels may not be significantly impacted by the new standard; however, companies that manufacture custom products or have complex contracts could be significantly impacted by the new standard. Companies must separately analyze each contract according to the five-step process outlined above.
Following are just a few of the key areas that will impact manufacturers and distributors:
|
Key Areas of New Revenue Recognition Standard |
What You Need to Know |
|---|---|
|
Variable consideration |
Manufacturers and distributors often provide sales incentives, including volume discounts and rebates to their customers, which create variable consideration. Measuring the amount of consideration to which the entity expects to be entitled is a key aspect of determining the amount of the transaction price, which ultimately determines how much revenue will be recognized.The new standard provides specific requirements for both estimating the consideration and constraining the estimate to the amount for which it is probable that a significant reversal will not occur. |
|
Adjusting for the time value of money |
Under the new standard, entities must adjust the transaction price for the impact of variable consideration, such as when a significant financing component exists. Payment for goods or services may come before or after control is transferred to the customer. If the payment period exceeds one year, the company needs to consider if there is a financing component as part of their revenue recognition. |
|
Multiple-deliverable arrangement |
Entities identify and obtain a thorough understanding of the nature of each performance obligation identified. With this information, an entity will assess whether a performance obligation is able to be recognized over time, or if not, at a point in time. The distinctness of goods or services will impact the allocation of the transaction price. The amount allocated to each performance obligation is ultimately what an entity expects to recognize as revenue when each respective performance obligation is satisfied. |
|
Warranty |
Many warranties contain characteristics that are similar to service contracts, and may be separate performance obligations. A portion of the sales price in such a contract must be allocated to the service and recognized separately over the applicable service period. |
|
Performance obligations satisfied at a point in time |
If a performance obligation is satisfied at a point in time, revenue in the amount of the transaction price allocated to that performance obligation is recognized when control of the good or service is transferred. Control is transferred when the customer has the ability to direct the use of and obtain substantially all of the remaining benefits from the good or service. For manufacturers and distributors, the concept of transfer of control may not uniformly align with existing practices of recognizing revenue when the risks and rewards of ownership have passed to the buyer. Entities will need to analyze their agreements to understand when control is transferred. |
For public companies, the new rules should be applied for all annual reporting periods beginning after December 15, 2017. For nonpublic companies, the standard should be applied to annual reporting periods beginning after December 15, 2018. The adoption of the new standard will impact each company differently. This means that companies must evaluate their existing contracts and accounting policies to assess how they will be impacted and ensure they are ready for implementation.
What Does CohnReznick Think?
While implementation of the new revenue recognition standard has been delayed in the past, CohnReznick believes the current effective dates will stand firm and that manufacturers and distributors should assemble the resources they need and evaluate their contracts and accounting policies now to ensure smooth implementation by the effective dates.
Contact
Visit CohnReznick’s Revenue Recognition Resource Center for further understanding on how your business can prepare for compliance. Stay tuned for our live webinar in November focused on revenue recognition compliance for manufacturers and distributors.
To discuss preparation for the new standard and how it may impact your business, please contact:
Swami Venkat
Partner, CohnReznick Advisory
swami.venkat@cohnreznick.com
973-871-4044
Gordon Chatterton
Senior Manager
gordon.chatterton@cohnreznick.com
404-250-6924
Brian F. Hickey
Senior Manager
brian.hickey@cohnreznick.com
959-200-7248
This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its members, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
Subject matter expertise
Swami Venkat
CPA, CISA, CFE, ACA, Partner, CFO Advisory Leader
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This has been prepared for information purposes and general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.