Private companies grapple with new revenue recognition standard
- March 29, 2018
- Posted by: Hood & Strong
- Category: Uncategorized
The AICPA is asking the Financial Accounting Standards Board (FASB) for special breaks for private companies as they implement the new revenue recognition standard, which goes into effect for private companies in 2019. The AICPA is asking for practical expedients for private companies to estimate performance obligations in a customer contract, as well as for the FASB to reconsider the definition of a “contract” for private company accounting purposes.
Here’s more on why private companies are struggling to adopt the standard and why they need to get serious about implementation.
Request for reprieve
With less than a year before private companies following Generally Accepted Accounting Principles (GAAP) have to comply with Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, the AICPA’s Private Companies Practice Section in January asked the FASB for relief.
“We believe that the magnitude and significance of the new revenue standard warrants robust consideration of recognition and measurement differences for private companies as well as disclosure differences for certain conduit debt obligors,” the AICPA letter reads.
The standard converges the rules for recognizing revenue under U.S. Generally Accepted Accounting Principles (GAAP) with new accounting rules published by the International Accounting Standards Board (IASB). Public companies must begin employing the standard with their Securities and Exchange Commission filings in the first quarter of 2018.
The FASB published the revenue standard in May 2014. It calls for a single, five-step method by which most companies worldwide must recognize revenue. The implementation process will vary from industry to industry, often depending on the complexity of customer transactions.
For example, retailers that engage in relatively simple customer sales don’t expect to see significant changes in how or when they record revenues. But some big-box stores have said they expect to see changes because the treatment of unused gift card balances will differ under the new accounting. Other industries — such as software, telecommunications and media — use specialized, long-term contracts, and many companies in those industries expect to make major changes to how they record revenues.
Which aspects of the new standard are causing private companies trouble? The AICPA’s letter asked that private companies be allowed to employ less restrictive interpretations for five aspects of the new standard, including:
- Definition of a contract. The new standard defines a contract as “an agreement between two or more parties that creates enforceable rights and obligations. Enforceability of the rights and obligations in a contract is a matter of law.” By contrast, under the old rules, a contract must only be “realizable,” a relatively lower barrier. The new definition could result in delayed recognition of revenue if a deal doesn’t satisfy the formal definition of a contract.
- Performance obligations related to customer options. The AICPA also asked the FASB to clarify a piece of the new revenue recognition model which requires that customer options for additional goods and services that are a material right be considered distinct performance obligations. Identifying and quantifying the new units of account will require a level of internal controls not typically found at many private companies. The letter asked that private companies be allowed to continue to apply, by accounting policy election, the incremental cost method for customer options for additional goods and services that are a material right.
- Short-cycle manufacturers. The AICPA wants private, short-cycle manufacturing companies to be allowed to recognize revenue when their products are shipped, rather than having to assess contracts to determine if the revenue should be recognized over time.
- Out-of-pocket costs. The letter requested a practical expedient that would let private companies recognize revenue for out-of-pocket costs that are reimbursed by the customer, based on the amount to be reimbursed when the costs are incurred. Under the new standard, out-of-pocket costs must be estimated as part of the contract’s transaction price and recognized as revenue.
- Nonprofit conduit debt obligators. The letter asked that not-for-profit groups that are conduit debt obligors be allowed to follow the new accounting standard as of the 2019 effective date for private companies.
The AICPA acknowledged that these requests are last minute. But, as the AICPA examined the standard’s details, they realized more clarity was needed from the FASB.
“My mom always said, ‘If you don’t ask, the answer’s always no,’” said Michael Westervelt, chair of the Private Companies Practice Section’s committee on technical issues.
The FASB doesn’t normally provide detailed, public responses to individual comment letters. As the FASB reviews the AICPA’s letter, it’s important for private companies following GAAP to move forward with the implementation process — in case the FASB doesn’t grant the requests.
Adopting the changes under the new revenue recognition standard will require significant effort, including analyzing customer contracts, designing and installing new financial reporting systems, and upgrading financial reporting controls to deter fraud. The shift from rules-based accounting to more principles-based guidance also is expected to be a significant cultural shift for U.S. companies. Contact your CPA for assistance and to discuss the latest developments from the FASB.