New Revenue Recognition Standard is Fast Approaching
It’s taken a long time and a lot of refinement, but the new standard to recognize revenue is lurking around the corner and becomes effective for private companies with reporting periods beginning after December 15, 2018. So, the question is…are you ready?
What is this New Standard?
Accounting Standards Update (ASU) 2014-09 establishes the following core principle: recognize revenue to depict the transfer of 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.
This replaces the current focus on recognizing revenue when risks and rewards are transferred, with an emphasis on when a change in control occurs.
Does this Standard Affect my Business?
Maybe. Do you have reporting requirements that require you to prepare financial statements in accordance with U.S. GAAP? If so, then you must consider this new standard. Luckily for you, it shouldn’t have a significant impact on how Architects, Engineers, and Contractors recognize revenue; as long as your company is recognizing revenue along with the effort incurred.
Just be aware that there are twists and turns to the new standard that you need to consider.
What do I Need to Know?
With the new accounting standard, a major point to remember is that revenue recognition should reflect the transfer of goods and services to a customer in an amount the entity expects to be entitled (for those goods or services). In general, firms billing for time won’t be impacted much by the standard. If the service creates value to the customer as a function of time incurred, the firm has earned the revenue.
The core revenue recognition principle is that revenue should be recognized 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. In more basic terms, this means that Architects, Engineers, and Contractors will continue to recognize revenue based on effort incurred, for the most part.
The application of the following five steps guides the recognition of revenue pursuant to the core principle. Particular attention should be paid to Steps 3 and 5, which is where most firms will see an impact.
- Identify the contract with a customer;
- Identify the separate performance obligations;
- Determine the transaction price;
- Allocate the transaction price to the performance obligations; and
- Recognize revenue when (or as) the performance obligation is satisfied.
Other Important Considerations
Variable consideration is going to be an area that will likely cause the most angst. Determining the value of variable consideration falls under Step 3. Some examples of variable consideration are:
- Pending change orders
- Liquidating damages
- Unpriced change orders
- Any incentives or penalty provisions.
Determining the value of these will require a deeper understanding of each one and the probability of occurrence. So important is this new standard, it should trigger companies to reach out to their software vendors to ask what they are doing to help customers meet the updated standards and the disclosure requirements.
First Year Transition and Disclosures:
Although the new standard doesn’t take effect until 2019, it does require prior periods that are being presented to be adjusted retrospectively. You will have a choice though in how to apply these changes:
- Retrospectively to each prior reporting period presented in accordance with the guidance on accounting changes; or
- Retrospectively with the cumulative effect of initially applying the standard at the date of initial application.
Financial statement presentation has minimal changes to the actual statements themselves, but the disclosures will require a more in-depth approach. The disclosure objective is for the presentation of sufficient information to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. To achieve that objective, disclosures should include qualitative and quantitative information about all the following:
- Contracts with customers;
- The significant judgments, and changes in the judgments, made in applying the guidance to those contracts; and
- Any assets recognized from the costs to obtain or fulfill a contract with a customer
Essentially, there are no minimum disclosures required, but instead, the disclosures must be adequate to meet the objectives of disclosures within the standard.
This is Going to be Too Difficult. What Can I Do?
If you are not preparing financial statements in accordance with U.S. GAAP, there really is no need to evaluate the new standards. If your bank is requiring a U.S. GAAP based financial statement, you may want to ask them if they will accept an exception from your accountant so that you can continue recording revenue as you always have.
As you may glean from all the information included in this blog, the new Revenue Recognition Accounting Standard is full of details and complexities. To learn more about the impact the new standard will have on the AE and Construction industries, including the potential for significant changes to your current accounting policies, watch our on-demand presentations titled Ready or Not: Your AE Firm & Revenue Recognition Changes and/or Construction & Revenue Recognition: What You Need to Know.
If you would like to continue the conversation and determine what it means specifically for your architectural, engineering, or construction firm, please reach out to me today.