As we transition to the new revenue recognition standard, 2 immediate questions are (1) how is this different from current practice, and (2) how will the transition be reflected in financial statements?
The answer to the first question depends on what industry you’re in and how your contracts are written. Currently, some industries have their own methods for recognizing revenue, which can differ even for economically similar transactions. The new guidance will be more consistent across industries. A couple examples of this are:
- Construction: Revenue will be recognized similarly to what’s now called the completed contract method – recognize it when assets are transferred to the customer. A limited exception would be if the customer has control of the asset during construction or development, in which case you can recognize revenue throughout the process of completing the performance obligation.
- Agriculture: Revenue will no longer be recognized when inventory increases in value, in the absence of a contract. It will only be recognized under a contract when goods or services are transferred to a customer.
- Contract Costs: When the costs of acquiring a contract are recoverable, they can be capitalized more frequently than under current GAAP.
- Judgments and Estimates: Management of your organization will be expected to make more estimates than under current practice. A prime example of this is variable consideration – if and how much the price of performance obligations, or a contract as a whole, is likely to change over time.
- Disclosures: You will have to make more revenue-related disclosures in your financial statements, such as details about contract balances and performance obligations, and estimates you’re making in how you recognize revenue.
For financial statements that include information from prior years, there are 3 methods for the transition:
- A full retrospective approach, applying the new revenue guidance in each prior period.
- A retrospective approach using practical relief. There are 3 forms of relief available; you can use any 1, 2, or all 3 of them.
- Contracts that start and end in the same fiscal year don’t need to be restated.
- Contracts with variable consideration can be adjusted in hindsight, using the transaction price when the contract was completed instead of estimating variable consideration at the start of the contract.
- For reporting periods presented before the date you adopt the new standards, you’re not required to disclose the portion of the transaction price allocated to remaining performance obligations, or an explanation of when you expect to recognize that revenue.
- The cumulative effect approach. Only use the new revenue standard for contracts that are incomplete under current GAAP when you implement the new standard. Without restating prior years, recognize the cumulative effect of the standard by adjusting the opening balance of retained earnings (net assets, for nonprofit organizations). If you use this approach, you’re required to make additional disclosures about the impact of adopting the new standard.
Accounting firm BDO goes into more detail for these topics, and also answers a few other frequently asked questions about the new revenue standard, in this report.