Since 2008 businesses and business owners have lived through a recession, sequestration, the new health care bill and now a change in how businesses recognize revenue. Yes, I said the way virtually every industry, including construction, now recognizes revenue will change. Now that I have your attention you are probably asking why this is happening and when this will begin.
Well, the why is because the accounting standard Gods, FASB, believe businesses need a single, principle-based revenue standard. This new standard is aimed at improving accounting for contracts with customers. This improvement is believed to provide a better framework for addressing revenue issues, to increase the comparability across different industries, and require better disclosures. When will the new standards go into effect? The final standard is scheduled for release during the first quarter of 2014. It will be effective for public entities for annual periods ending after December 15, 2016 and for nonpublic entities for annual periods after December 15, 2017.
So the FASB has defined what they call a “core principle” in applying the new standard. The core principle is to “recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services”. In order to implement this “core principle”, and for companies to determine when to recognize revenue, a five step process is being introduced as guidance:
1. Identify the contract(s) with the customer.
A contract is defined as an agreement between two or more parties that creates enforceable rights and obligations. Additional analysis is required when two or more contracts are entered into at or near the same time with the same customer or for any contract modification that may occur.
2. Identify the separate performance obligations in the contract.
Performance obligations would be identified at contract inception and determined based on contractual terms and customary business practices. A contract can be written with multiple performance obligations that are distinct and should be accounted for separately, which the FASB has established a two-step process to determine.
3. Determine the transaction price.
The transaction price would be the amount of consideration that an entity expects to be entitled to in exchange for transferring goods or services. The transaction price would reflect the effects of multiple financial considerations.
4. Allocate the transaction price to the separate performance obligations.
The transaction price of a contract with one or more separate performance obligations shall be allocated in “an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for satisfying each separate performance obligation”. The allocation of this price is generally based on relative standalone selling prices, however there are two potential exceptions relating to contingent consideration and discounts if specified criteria are met.
5. Recognize revenue when each performance obligation is satisfied.
The last step to this process is to recognize revenue when a performance obligation has been satisfied by transferring the good or service to a customer. The FASB indicates that the performance obligations can be satisfied over time or at a point in time.
The above information is just a summary of the five step process that could have a substantial impact on your business. Additional changes to highlight are new disclosure requirements that have been attached to the standard, contract terms and business practices that may need to be updated, and these new standards could affect your financial ratios and performance statistics.
It is important that you seek advice from your accounting professional as to how these new standards will impact your specific business.
Article Provided By Wayne Baldwin, CPA, MKS&H Principal.
McLean, Koehler, Sparks & Hammond (MKS&H) is a professional service firm with offices in Hunt Valley and Frederick. MKS&H helps owners and organizational leaders become more successful by advising them regarding their financial, technology and human capital management needs.