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Financial Management to Be Thankful ForAs we discussed in the previous article on September 8th, the way in which revenue is recognized will change substantially by 1/2017.  So, how is revenue recognition changing?

The new process for recognizing revenue is as follows:

  1. Identify the contract with the customer
  2. Identify the performance obligations in the contract
  3. Define the transaction price
  4. Allocate the transaction price
  5. Recognize revenue as each performance obligation is satisfied

While this process may hold some similarities to how you recognize revenue today, there are some significant differences.

As it relates to revenue recognition, a contract could be a legal contract as you might normally think, but it could also be a sales order or a Statement of Work/Arrangement letter.  It represents the agreement with the customer to provide goods and/or services and to be compensated for those goods and services.

A performance obligation is a new term in the revenue recognition vocabulary.  A performance obligation is a promise in a contract with a customer to transfer a good or service to the customer.  If you are a widget manufacturer, this remains fairly simple to handle.  It is likely that line items or groups of lines items on your sales orders will equate or closely equate to performance obligations.  However if you sell goods along with a service such as installation or sell only services, the mapping of current services to performance obligations can be a complex exercise.  The performance obligation must be distinct, meaning the good or service is readily usable by the customer and can be delivered separate from other performance obligations in the contract.  These new definitions are going to have a material impact on the way revenue is recognized for longer term installation efforts and services delivered in a project-oriented manner.  Companies will need to rethink how milestone and progress payment oriented arrangements are structured.

The transaction price is the amount of consideration a company is expecting for transferring a good or service to a customer.  The key things to consider with setting a transaction price are variable considerations.  Variable considerations are compensation impacts like discounts, rebates, refunds, incentives.  In addition, the collectability of the compensation must be considered.  If there is only a 50% likelihood that a payment can be collected from a customer, then the revenue to be recognized must be reduced to account for this.

Due to the above complexities, and others not covered in this article, suffice it to say, that you will need to engage both your finance department and an accounting firm in evaluating your performance obligations and transaction prices and helping you to set new accounting standards and policies.

In the next article, we will discuss the significant operational impacts of these accounting changes and what that means to your business data, processes, and information systems.