The biggest accounting standards change since the implementation of the Sarbanes Oxley Act back in 2002 is hitting the accounting profession – a change to the revenue recognition standards. This new standard, known as Accounting Standards Codification (“ASC”) 606- Revenue from Contracts with Customers, is one that will change the face of accounting for almost any business. Although for private companies this standard is not in effect until fiscal years ending after December 15, 2019 (for December 31 year-end clients, this means it will be effective for December 31, 2019, and for September 30 year-end clients, this means it will be effective for September 30, 2020), companies will need to start planning for these changes now.
Let’s first understand the reason for these changes and then move on to understanding the changes in the standard.
Why?!:
In order for accounting principles generally accepted in the United States (“U.S. GAAP”) to converge better with International Accounting Standards (“IAS”). This new revenue recognition standard, ASC606, mirrors IAS15. What does this mean? For companies that have a foreign parent, the revenue that is recognized under U.S. GAAP will be in compliance with the revenue that is recognized under IAS.
Current Revenue Recognition Standards: Currently, there are four criteria that must be met in order for a company to recognize revenue:
- Persuasive evidence that an arrangement exists
- Delivery has occurred or services have been rendered
- Price is fixed and determinable
- Collectability is reasonably assured
This standard is subject to interpretation, and includes many carve outs for different types of businesses; such as construction contractors, lessors, healthcare, etc.
New Revenue Recognition Standards: Instead of using the above four criteria, companies must now move to a five step approach to determine how their revenue will be recognized.
- Step 1: Identify the contract
- Step 2: Identify the performance obligations (promises in the contract)
- Step 3: Determine the transaction price
- Step 4: Allocate the transaction price to the performance obligation in the contract
- Step 5: Recognize revenue when (or as) the seller satisfies a performance obligation
In Layman’s terms: Revenue is recognized as the price a seller expects to receive in exchange for the transfer of control of promised products or service to its customers.
There are very few carve-outs, as all types of businesses will be required to follow these new standards (few exceptions including lessors).
Basically, the standards are changing from a rules-based approach, to a principles-based approach, which means lots of management judgement will be involved in making decisions regarding their different revenue streams.
Issues:
- Software capabilities
- If companies have various ways to recognize revenue (i.e. percentage of completion, completed contract, and straight line over a period of time), most current software does not contain the ability to recognize revenue differently.
- Sage Intacct is one of the only softwares that is certified by the American Institute of Certified Public Accountants as being compatible with the new standards.
- Cost
- Dollars to change current systems if current system is not compatible with new standards (i.e. Quickbooks, Peachtree, etc.)
- Time spent making management decisions, and re-evaluating at each period a financial statement is presented.
- Additional disclosures
- Even for companies that may not be as heavily impacted by the revenue changes, there are more disclosures required. These disclosures will discuss management decisions regarding the revenue streams.
Tax Implications:
There is a proposed revenue ruling out discussing the effects of this revenue recognition change for tax purposes. The IRS has requested comments from practitioners on the change and procedures to be followed for tax compliance. The proposed regulations by the Commissioner of Internal Revenue are stating if the change is adopted in the year required for U.S. GAAP, an automatic change may be allowed on Form 3115, Application for Change in Accounting Method. Under the regulation, the Internal Revenue Code (“IRC”) § 481(a) may allow an adjustment for income over four years. A small business with assets below $10 million on the first day of the taxable year or average annual gross receipts of $10 million or less for the three preceding tax years is not permitted or required to make an IRC § 481(a) adjustment.
How Can CDH Help?:
- Sign up to receive our newsletter for additional information
- Seminars/Webinars to go over changes in more detail
- Implementation of software that is able to record revenue according to the new standard’s specifications (CDH is a value added reseller of Sage Intacct and can assist you with its implementation).
- Trusted advisors – we can assist your company as you navigate this new change.
If you have questions on the new standards, please reach out to your CDH contact or to Andrea Krueger, Wendy Kelly, Tomoko Nakao, or Emily Bartlett, to set up a meeting to discuss further. We look forward to touching base with all of our clients to assist them with these changes.