Credit & Capital

Standard Setters Issue Final Revenue Recognition Rule

At many companies, CFOs will have to oversee a transition to broader disclosures on revenue recognition.
David KatzMay 28, 2014

After more than a decade of deliberation, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued a final standard this morning on the recognition of revenue from contracts with customers.  For CFOs working for companies in the software, telecom, real estate and asset management industries, specifically, complying with the new rules could involve big overhauls in their accounting methods and systems, top standard setters said. But at a much broader swath of companies, finance chiefs will at least have to oversee a transition to broader disclosures on how sales are recognized.

ROSIESOFTWAREThe new standard, which will replace more than 200 ad hoc pronouncements on revenue recognition, will become effective for public companies with annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period.

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For non-public companies, it’s effective for annual reporting periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018.

At its core, the new standard requires companies to recognize revenue in a way that shows the transfer of goods or services to customers in amounts that reflect the payment the company “expects to be entitled to in exchange for those goods [or] services,” according to a press release issued jointly by the two standard setters.  To do that, companies will now have to go through a five-step process: 1) tie the contract to a customer; 2) identify the contract’s performance obligations; 3) determine the transaction price; 4) connect the transaction price to the performance obligations in the contract; and 5) Recognize revenue when (or as) the company satisfies a performance obligation.

Asked by CFO to describe the biggest challenges the new standards pose for corporate preparers of financial statements, FASB Chairman Russell Golden said at a press conference today that the challenges will vary by industry. “If you’re coming from an industry where the basic model is consistent with what you do today, you’ll need to evaluate your processes and systems and internal controls. And you will have increased disclosures,” he said.

Companies from industries like software in which revenue recognition hasn’t been consistent with what the standard will call for will likely have internal controls, processes and system changes as well as disclosure improvements, according to Golden. In addition, however, such companies “will  have to make an informed decision as to the transition methodology,” he said, noting that preparers can recognize the transition by either reporting the cumulative effect of past periods or by applying the standard retrospectively.

“You will also have to start working with investor relations to give a signal to the street about how your revenue numbers would change,” the FASB chairman added.

Ian Mackintosh, vice chairman of IASB, said that for many companies who file under International Financial Reporting Standards (IFRS), “there won’t be much change” under the new standard. There could be changes for IFRS filers in recognizing revenue in long-term service arrangements and deals involving a variety of different sales and product elements, he said.[contextly_sidebar id=”9c753f18ff95457608afb379ecf717ac”]

Strongly opposed by many finance and accounting executives, the changes in revenue recognition could have a ripple effect on loan covenants, compensation packages, discounts and rebates and taxes, experts said before the standard was issued. The standard setters, of course, feel differently. “The standard will improve the financial reporting of revenue and improve comparability of the top line in financial statements globally,” the rulemakers said in a jointly issued press release.

“Revenue is a vital metric for users of financial statements and is used to assess a company’s financial performance and prospects. However, the previous requirements of both IFRS [international financial reporting standards] and US GAAP [generally accepted accounting principles] were different and often resulted in different accounting for transactions that were economically similar,” according to the release.

The rulemakers emphasized that the increased disclosure requirements mark a sharp departure from past revenue recognition reporting. For example, Golden noted, the standard requires companies, especially software firms, to disclose their “backlog” of deals.  That could help “investors understand the future pipeline to revenue,” he said, which could enable them to “predict future revenue and future earnings.”

To help companies and others with the changeover, the boards have set up a joint transition resource group that will meet publicly until the standard goes fully into effect.  “We’re hoping this will be educational. It will not be a decision-making body,” said Mackintosh, adding that he hopes the group will have its first meeting in July.

“It will be a body that listens to the problems or difficulties that people have. Hopefully, in most cases, [the group] will be able to point out that the standard adequately covers the situations that they are looking at. If the standard doesn’t cover those, then it’ll be referring the problem back to the board[s],” he said.

Image by: Iwan Gabovitch