Dee Mirando-Gould Executive Director, Technical Accounting Resource Center MorganFranklin Consulting
Revenue is the most important number in any company’s financial statement—and it is changing. Companies face numerous challenges as they transition to Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, but those that start early and in earnest may also benefit from valuable opportunities.
In May 2014, the Financial Accounting Standards Board (FASB) issued the new standard, which introduces substantial changes to how companies approach revenue and also provides for expanded disclosure requirements in its aim for greater consistency and comparability across industries and in global capital markets. But due to the complexities of the standard, many companies have yet to dig into the pages of additional compliance requirements, terms, and judgment areas. Even fewer have sorted out what the changes mean and how they will impact operational policies and processes.
Reading and understanding the new standard requires a significant investment of time and resources that pales in comparison to the effort required to assess its impact on financial statements and the bottom line. With no precedent for how to transition to the new model, companies are reluctant to begin, opting instead to wait for peers to lead the way and provide additional guidance on path and process. However, those waiting for someone else to set an example will find themselves with inadequate time to prepare as the effective date for the new standard approaches. Even though the FASB approved a one-year deferral of the original effective date, companies may still need every minute of the additional time to prepare for the changes required by the standard.
Despite these challenges, companies that invest the effort to understand and adopt the standard now stand to gain significant opportunity. Through assessing and evaluating, optimizing and refining, and preparing for changes brought on by the standard—regardless of industry or size—companies can position themselves for future success.
Better Understanding Yields Better Decision Making
Before approaching the substantial amount of work required to transition to the standard, companies must invest an equally significant amount of time and effort to understand the requirements and impact. With that analysis in hand, they can then select the appropriate transition method to tell a consistent financial story. Assessing the impact of each transition method on hundreds (or even thousands) of existing contracts could take months for already over-taxed Accounting departments.
Though transitioning to the new model requires this analysis, the truth is that this work should be done regardless. Reviewing current contracts to gain a better understanding of established business processes and policies will pave the way for optimizations, mitigation of contractual risk, and even changes to contract terms. In turn, this will provide flexibility and perhaps set forth a more desired revenue recognition pattern upon fulfillment of contract terms and obligations. Further, it could yield big gains in efficiency and effectiveness. For example, software companies have long included support renewal rates in contracts to meet requirements for recognizing revenue on license sales—a practice that is no longer necessary under the new rules.
Each time an organization issues a financial statement is an opportunity to tell a story about the business, its value, and its prospects for the future. With a clear understanding of the standard’s impact, companies can make better decisions—not just about which transition method to use but also how they want to recognize revenue in the future—that fall in line with the story they want to tell.
Companies intrigued by the opportunities but still daunted by the amount of work required have found success in bucketing contracts by type and evaluating representative contracts.
Bringing Teams Together Enables Company-Wide Optimization
A standard handed down by the FASB is not likely to reach the radar of those sitting in the Human Resources, IT, Marketing, or Sales departments. Even those with backgrounds in the concepts and terminology are overwhelmed by the standard, leading many companies to hold the documentation close within Accounting.
However, adjusting to the standard requires a company-wide effort due to its far-reaching impact across the entire business, including tracking additional data, implementing more controls, and establishing appropriate processes and procedures. The responsibility to understand and lay out the path may rest with Accounting, but tasks such as developing new systems for tracking, collecting and reporting on added data points, and establishing suitable processes also fall to IT, Contracts, Finance, Tax, and Internal Audit. Opening up change to the wider company may not lighten the load, but opening up opportunity to the enterprise often yields positive results. Inviting a company-wide cross section of teams to engage in the process empowers every department to consider optimizing existing systems and processes.
The standard presents an opportunity to optimize existing policies and processes—not just those within the Accounting department. Bringing teams together to evaluate the current state enables a more complete view of the impact of the changes and presents opportunity for company-wide optimization.
Companies must select a transition option.
Revenue is now recognized when a customer obtains control of a good or service—not simply upon the transfer of risks and rewards.
Virtually all existing rules-based revenue guidance is eliminated.
New judgments and estimates are required.
New qualitative and quantitative disclosure requirements are included.
There is a new five-step approach to analyzing contracts.
Other financial areas may be impacted.
Effective dates differ for public vs. private companies:
Public companies with annual reporting periods beginning after December 15, 2017—early adoption is allowed, but not before the original public company effective date (i.e., annual reporting periods beginning after December 15, 2016).
Non-public companies with annual reporting periods beginning after December 15, 2018—early adoption is allowed, but only as of annual reporting periods beginning after December 15, 2016.
Early Assessment Leaves Time for Action
Nothing halts progress faster than fear of the unknown. And with no precedent or set of leaders demonstrating how the changes and impacts play out, life under the new standard is largely unknown. Financial statement adjustments rarely occur without impact, and those fearful of the effects have delayed adoption due to what they may find. Others believe there will be little to no change in implementing the standard, so they have chosen to delay adoption. However, no one will know the true effects until they begin the assessment.
Some companies have begun the assessments and found their bottom lines increasing due to capitalizing costs or bringing revenue forward to recognize more revenue on current contracts. Alternatively, some have found that they are deferring revenue because the standard requires more performance obligations. Still, others have seen positive impacts on their financial stories because they will no longer need to follow the prescriptive rules under the existing standards.
And if the impact is not as hoped for or anticipated? The old adage holds true: Bad news does not get better with age. A company that assesses the standard’s impact on its financial picture sooner rather than later can take immediate action by establishing clear lines of communication with stakeholders and establishing processes to operate under the new norms.
The standard is voluminous and complex, but it is not going anywhere—and transitioning will require work. Companies that begin transitioning sooner rather than later will be able to proactively manage stakeholder communications regarding the impact and seize strategic opportunities.