New Accounting Standards for Revenue Recognition
The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) have approved new accounting rules on recognizing revenue in customer contracts. The new rules are principles-based, eliminating most of the industry specific revenue recognition guidance by generally accepted accounting principles in the United States of America. This change will remove inconsistencies in existing revenue recognition standards and improve comparability of revenue recognition practices over a range of industries and geographic boundaries to provide more useful information to users of financial statements.
The core principle of the new rules is that revenue should be recognized upon the transfer of promised goods or services to customers in an amount reflecting the consideration the entity expects to be entitled to in exchange for those goods or services. The new rules require a five-step approach.
Step 1: Recognize the existence of a contract. A contract exist if it is approved by all involved parties, has commercial substance, gives enforceable rights to involved parties, and has payment terms.
Step 2: Identify performance obligations (goods and services promised) to the customer.
Step 3: Determine the transaction price entitled under the contract. If the consideration is variable, companies need to estimate the most probable price to be received. If the consideration is expected to be received over time, the transaction price should be discounted.
Step 4: Allocate the transaction price to each performance obligation.
Step 5: Recognize revenue when performance obligations are satisfied. The performance obligations are considered satisfied when control is transferred to the customer.
The new rules are effective for years beginning after December 15, 2016 for public companies and years beginning after December 15, 2017 for nonpublic companies. Companies should review their internal control processes to ensure they are able to gather additional information necessary for the new requirements and involve external auditors in implementation planning for the new procedures.
Vanessa Mun, Senior Accountant
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