6 Questions Manufacturers Should Ask about Their Revenue Recognition Progress (article)
Starting this year, private manufacturers must follow the new guidance for recognizing revenue from contracts with their customers. ASC Topic 606, Revenue from Contracts with Customers, takes effect for 2019 financial reporting for private business entities. Public companies had to adopt the new revenue recognition standard for their 2018 financial statements.
Manufacturing companies are uniquely affected by the changes to the revenue recognition model due to their high volume of contracts. Certain elements of the guidance may require particular attention as they could pose a significant change from previous GAAP or judgment. The following questions can help manufacturers determine their preparedness for taking on the new standard.
Have I combined the appropriate contracts?
Manufacturers often enter into multiple contracts with the same customer on or about the same time. Under previous GAAP, combining contracts that met certain conditions was optional. Topic 606 makes it required when one of the following conditions is met:
- The contracts are negotiated as a package with a single commercial objective;
- The amount of consideration to be paid in one contract depends on the price or performance of the other contracts; or
- The goods or services promised are a single performance obligation.
Some judgment may be involved in determining whether multiple contracts with the same customer meet the new standard’s combination criteria.
Are my warranties classified correctly?
Warranties may represent a separate performance obligation. One of the indicators is that the same warranty is regularly sold on a standalone basis and provides more than basic assurance on the good or service’s quality or performance.
Are my volume rebates and discounts appropriately reflected in the transaction price?
Manufacturers may offer their customers volume rebates or discounts. If the volume discount provides the customer with the option to purchase future products at a discount, manufacturers should account for the volume rebate as a material right.
Rebates for the bulk purchase of goods or services are treated as a form of variable consideration. Companies with volume rebates will need to use some judgment when determining the transaction price for contracts with volume rebates. They should consider the impact of the rebate on the contract, their experience with the customer or similar customers, and other qualitative factors in order to estimate the transaction price.
Have I allocated variable consideration to the right performance obligations?
Variable consideration and discounts may be related to one or more but not all performance obligations in the contract. Manufacturers will allocate variable consideration to a specific performance obligation when the terms of the discount relate specifically to the obligation or transfer of the good or service and the outcome is consistent with the allocation objective. An entity allocates a discount to a specific performance obligation if the entity regularly sells each of the distinct goods or services on a standalone basis and regularly sells a bundle of some of those distinct goods or services at a discount.
Am I using the right revenue recognition model?
Revenue in ASC Topic 606 is recognized at either a point in time or over time based on how the good or service is transferred to the customer. Manufacturers will recognize revenue over time if one of the following conditions is in place:
- The customer has a right to the benefits provided by the contract as the manufacturer fulfills the contract;
- The manufacturer modifies an asset (work-in-progress) that the customer controls; or
- The manufacturer does not have an alternate use for the asset being created or transferred, and it has a right to payment for the asset.
The over time recognition model may result in manufacturers recognizing revenue sooner for the production of customized goods.
Do I have the right measure of progress for over time revenue recognition?
If manufacturers determine their contracts qualify for the over time model of revenue recognition, they will need to evaluate the specific facts and circumstances of their production process to determine the best measure of progress for revenue recognition.
Entities can use either the output method or the input method as the measure of progress. With the output measure, manufacturers would recognize revenue by directly measuring the value of the good or service that has been transferred to the customer in proportion to the total value of the good or service being transferred to the customer. Common output measures include units produced over units delivered and milestones reached.
Manufacturers may want to use the input method if the value of the effort put into creating the good or service being transferred to the customer is more readily available than the output. Common input measures include labor hours and machine hours.
Have questions? For a deeper dive into your organization’s preparedness for revenue recognition, feel free to contact the author, Bob Batz (firstname.lastname@example.org or 727.572.1400), your local CBIZ MHM advisor or contact our MHM office directly.