In business, like life, you want every advantage you can get. We can’t help with everything, but we do have 6 tips to help you understand FASB’s new revenue recognition rules and how they affect technology companies.
GAAP Guidelines in Effect Before 2019
The current GAAP guidelines for revenue recognition have long contained industry-specific rules. To determine when to recognize income, accounting staffs familiar with GAAP rely heavily on terms such as “persuasive evidence of an agreement”, “delivery”, and “fixed or determinable fees”.
FASB tossed out these concepts when it issued the new revenue recognition rules. This will present a significant issue for technology companies who have been quite comfortable with the stricter rules under the current GAAP setup. An example of the current rules are the vendor-specific rules that rely on objective evidence under the “fair market value of post-contract support” standard which GAAP required in order to unbundle a software agreement.
FASB Revenue Recognition Rules
These rules are a different animal, indeed. FASB’s intent was to create a higher level of comparability among all industries. Instead of the rigid GAAP concepts described above, the new rules base compliance on a core set of principles and subjective judgments about how those principles apply to the contract. The company’s subjective judgments will determine how much revenue the company’s financial advisers recognize and when they recognize it. The basis of the new rule is that companies record revenue when the customers gain control over the products/services the company sells to them — not when earned as under the old rules.
Do the new rules accelerate revenue recognition for tech companies?
Yes. For instance, a technology company may charge part of the license fee on delivery of its product/service to the customer. The tech company can charge the rest of the fee over the post-contract support period. The new rules will affect cloud services, such as SaaS as an example, because the delivery of the service combines with support services under a contract and is in the nature of a lease.
So, how does a company determine the revenue under a contract?
That’s a great question because the first step is identifying the company’s contracts. That’s often an issue because contracts can take various forms for each customer.
After identifying the contracts, the company next undertakes an analysis of each contract to determine:
- what deliverable items it produces, delivers, or provides services connected to those deliverable items; and
- the performance obligations that apply.
Then, the company must decide from which of the identified deliverables the customer benefits. This is true whether the business sells the items as stand-alone or provided with other deliverable items (such as crafting a product that then has labor costs for installation).
In the final step, the company determines the overall price of the contract and then allocates the total price among deliverable items.
Once the parties complete the performance obligations as determined under the contract, the company can recognize the revenue.
Wow. This sounds complicated and likely to affect other company tactics and legal requirements
Oh, it does. Understanding how these new rules will affect your current contracts and the revenue streams of each is paramount. After that, it is important to understand how these changes:
- affect other performance-based obligations,
- create income tax implications, and
- affect the business’ internal controls.
What can we do now to prepare?
ASB set out various transition methods that may benefit your business. You may also need to provide staff training for accounting personnel. Continue to watch out for updates as FASB issues clarifications on the new rules. Remember that although 2019 may seem like a long way away, you do not want to waste precious preparation time.
To learn more about getting prepared for the new rules, read sbonline.com‘s article entitled “Are you prepared for the changes to revenue recognition and leases?”
To talk more about this, or anything else, please contact us. We look forward to helping you grow your business.