March 7, 2016

Revenue recognition: Short-term pain, long-term gain

For years, accountants have had to understand and adhere to different accounting rules in the U.S. and internationally. Among the many challenges that brings is the requirement that accountants learn specifics related to different industries and countries on how to recognize revenue. As a result, the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board, (FASB) began collaboration in 2002 on a series of convergence projects. The purpose of the joint initiative was to produce a compatible set of accounting standards - or rules - that could be applied across the world.

One of their first projects was to create a set of universal standards for revenue recognition, an accounting principle that determines how and when revenue should be reported in financial statements. In this three-part series, we will examine why the IASB and FASB set out to make these changes, the challenges businesses – and especially their accounting departments - might face during implementation and lastly, how firms should prepare ahead of the transition.

In our first installment, we will address some frequently asked questions about the new rules and what they will entail.

1.  When will the new standards take effect? For public companies, the standards will kick in during the fiscal year beginning after Dec. 15, 2017. In other words, for a December year-end, they would apply to your 10Q for the first quarter ending March 31, 2018.

Private companies will be required to implement the standards exactly one year later, beginning the fiscal year after Dec. 15, 2018.

2. How will the new revenue recognition rules change for small businesses? Navigation of the new revenue recognition rules is going to call for increased management judgment. In general, the rules are trying to better align accounting with the economics of the transaction. For example, variable consideration contingent on a future event may now be recognized throughout the life of a contract as opposed to only upon satisfaction of the future event. Changes such as this will require critical judgments to be made by accounting departments that often times, may lead to an acceleration of revenue recognition. 

3. How will businesses be affected? Businesses will find they have to disclose more. Currently, companies may only have one paragraph in their financials that discusses their revenue recognition procedures. Under the new standards, there will likely be several pages of disclosure, most of which will discuss the reasoning that led to management’s decisions and conclusions about how to recognize revenue.

This is mostly due to the fact that traditionally, international standards are highly principles-based, whereas U.S. standards are more rules-based. Because the new rules are conforming to a more principles-based approach - to simplify the application across the globe - a lot of judgment will come into play; management needs to outline the roadmap of their thought process, something that we’ll discuss further in a later post. 

4. Will this affect all industries the same? No, certain industries – such as software, construction, telecommunications and media & entertainment -- will be affected more than others. That’s because they traditionally have been governed by a significant amount of industry-specific guidance. Under the new regulations, there will not be guidance specific to certain industries; everything will be uniform.

5. What should businesses do now to prepare? At this juncture, businesses should continue to monitor the amendments being made by the FASB, as there are still several amendments that need to get finalized. Businesses should also make every effort to get up to speed on the standards so that when the time comes for implementation, they’re ready.

Thank you for reading part one of the revenue recognition series. You can find more information on the topic here. Also, be sure to stay tuned for parts two and three of this series, which will discuss the challenges businesses will face during and after implementation and how they should prepare ahead of the transition.

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