All US public companies prepare their financial statements to comply with generally accepted accounting principles (GAPP). When it comes to the new rules regarding revenue recognition, you don’t have to go it alone. Here are a few tips for handling it.
Let’s start with a few basics.
Revenue Recognition
Revenue refers to the influx of asset enhancement or liabilities settlement that results from your company’s services or products. Revenue recognition means the recording of such revenue on your business’s financial statements. Revenue recognition is an essential component of GAPP. It is often used to determine a company’s value and affects other critical financial measurements and ratios.
New Revenue Rules Affect All US Companies
All US companies will have to change the way they report revenue under the new rules and will have added disclosure requirements. How much the rules affect your business depends on where your business falls on the spectrum. Some companies will see little or not difference in their revenue numbers, although they will still have to understand and comply with the changes in the law. Others will see a lot of difference in their numbers, especially if the business relied in the past on industry-specific accounting guidance. The new revenue recognition rules supersede that industry-specific guidance once the new revenue recognition rules take effect. Industries affected by this change include real estate, financial services, software, entertainment, media, franchises, engineering, and construction.
The New Revenue Recognition Rules Affect More than Your Financial Statements
You might think that your accountant will bear the brunt of responsibility for the changes — and you would be right as far as the financial statements. However, the new revenue rules affect all kinds of agreements that your company undertakes with other entities. Here are just a few examples to give you an idea:
- loan agreements
- financial agreements
- management contracts
- executive compensation agreements
- award-based compensation agreements
- buy-sell arrangements
The change in GAPP’s revenue recognition rules affects these types of agreements because the answer to how and when the new standards recognize revenue depends on language contained in each agreement. Therefore, although your accountant will have the final say in revenue recognition for your company as far as blessing your financial statements, your attorneys also must understand your business’s revenue recognition objectives before they enter into contract negotiations.
The Core Change
After the new rules go into effect, all contracts that address the sale or exchange of goods or services to customers and the transfer of real estate and other non-financial assets must comply with one set of revenue principles. That set of principles mandates that companies recognize revenue from the exchange of goods and services in an amount that reflects the amount of compensation the company expects to receive for the goods and services. Therefore, the company must analyze the contract terms and make its judgment based on all the relevant facts and circumstances.
A 5 Step Process
To comply with the core of the new rules and know when and how to recognize revenue, each company must complete these five steps:
- identify the contract,
- identify the core obligations under that particular contract,
- figure out the total price under the contract,
- allocate the contract price portion that applies to each transaction under the contract, and
- recognize revenue when each obligation completes according to the terms of the contract.
This approach is a whole new way of analyzing and understanding how companies earn revenue under contracts.
Effective Date of the New Rules
The new revenue recognition rules for public companies applying GAAP is effective for reporting periods beginning December 15, 2016. For non-public companies, the new GAPP rules are effective for reporting periods beginning December 15, 2017.
To discuss this in more detail, or other related matters, please contact us. We look forward to sharing our ideas with you.