The Top 6 Practical Expedients for Revenue Recognition
The change from rules-based, industry-focused guidance to a one-size-fits-all, principle-based standard may result in significant changes to how companies account for their contracts with customers. Depending on facts and circumstances, some entities may find it complicated to implement the new revenue recognition guidance. To help simplify adoption efforts, the Financial Accounting Standards Board (FASB) has allowed for the use of certain practical expedients that private companies can elect for their ASC Topic 606, Revenue from Contacts with Customers (Topic 606) implementation effort.
The practical expedients are designed to make it easier to transition to and comply with the new standard, but they come with some considerations. When your organization elects to use a practical expedient, it will be required to use it for all applicable current and future contracts. The adoption of a practical expedient may require additional disclosure to illustrate the judgments used in applying the practical expedient.
Evaluating your practical expedient options can help reduce the burden of transition and make it easier to comply with the requirement of Topic 606 long-term. To help you with your evaluation effort, we’ve compiled six of the top practical expedients available under Topic 606 that should be on your radar.
1: Portfolio Approach
Perhaps the most significant practical expedient available is the option to apply Topic 606 to a portfolio of contracts (or performance obligations). To apply the portfolio approach, your organization would first evaluate a single contract with a customer using the guidance found in the new revenue recognition standard. Your organization can then use the same method to evaluate a portfolio of contracts (or performance obligations) with similar characteristics if you “reasonably expect” that the effects of applying the method to the portfolio of contracts on the financial statements would produce the same results as if you took each contract (or performance obligation) in the portfolio through the 5-step approach individually.
Your organization would account for its use of the portfolio approach by using estimates and assumptions that reflect the size and composition of the portfolio.
2: Costs of Obtaining a Contract
If your organization determines it would amortize the costs related to obtaining a contract in one year or less, it should consider the contract cost practical expedient. The option permits organizations to recognize the incremental costs of obtaining a contract as an expense when the contract costs are incurred.
3: Financing Component
If at contract inception, you expect that the period of time between the transfer of a contracted good or service to the customer and the period of time in which the customer will pay for that good or service is one year or less, you can elect not to adjust the amount of consideration for the effects of a significant financing component.
4: Right to Invoice
The right to invoice practical expedient permits organizations that recognize revenue from contracts over time to recognize revenue as invoiced if your organization’s right to payment is for an amount that corresponds directly with the value to the customer of your organization’s performance to-date. For example, a service contract in which an entity bills a fixed amount for each hour of service provided.
Organizations that use the practical expedient will recognize revenue by multiplying the price assigned to the goods or services delivered by the measure of progress (i.e., the quantities or units transferred). Therefore, you can effectively bypasses the steps of determining the transaction price, allocating that transaction price to the performance obligations, and determining when to recognize revenue (steps 3-5 of the 5-step revenue recognition approach). However, the practical expedient does not permit an entity to bypass the requirements to determine the performance obligations in the contract and evaluate whether the performance obligation is satisfied over time.
5: Shipping and Handling
The shipping and handling expedient might be a particularly useful practical expedient for manufacturers and retailers. If shipping and handling activities are performed after a customer obtains control of the good (traditionally FOB Shipping Point), then your organization may elect to account for shipping and handling as activities to fulfill the promise to transfer the good versus as a separate performance obligation. If revenue is recognized for the related good before the shipping and handling activities occur, the related costs of those shipping and handling activities shall be accrued–typically when the related revenue is recognized.
6: Sales Tax Accounting Policy Election
Organizations can elect to exclude all sales and other similar taxes from the transaction price. These similar taxes include use, value-added and some excise taxes that are imposed on revenue-producing transactions and collected from the customer by the organization providing the product or service. The sales tax accounting policy election permits organizations to present all collections from customers for these taxes on a net basis, rather than having to assess whether the organization is acting as an agent or a principal in each taxing jurisdiction. Should your organization make the sales tax policy election, it will apply it to all contracts.
For More Information
If you have specific comments, questions, or concerns about revenue recognition adoption, please contact us.