The New Revenue Recognition Standard (#179)
/In this podcast episode, we discuss the new revenue recognition standard. Key points made are noted below.
Nature of the New Standard
This is a principles-based standard, rather than a rules-based standard, which means that it includes general principles for how to recognize revenue, and you are supposed to use your own judgment in figuring out how to apply the concepts.
This standard applies to both GAAP and IFRS, so it is essentially the new worldwide standard for revenue recognition.
The Five-Step Approach
There is a five-step approach for revenue recognition. First, they assume that a transaction with a customer is being to be based on a contract, so you have to link a contract to the customer.
The second step is to list the performance obligations in the contract, which means the goods and services that the seller is selling to the customer. If you can’t identify a performance obligation, then you can’t recognize any revenue.
The third step is determining the transaction price that’s built into the contract. If the amount to be paid is variable, then set the price at the amount most likely to be paid. When setting the price, do not go so high that there will probably be a significant reversal of the cumulative amount of revenue that’s already been recognized.
The fourth step is to allocate the transaction price from step three to the performance obligations that were identified in step two. The main rule is to allocate the payment amount that the seller expects to be entitled to when it satisfies each performance obligation. One guideline is to allocate based on the standalone selling price of the individual goods and services in the contract. If there are no standalone prices, then you can estimated it. Another option is the residual approach, which involves applying the total price to everything in the contract that does have a standalone selling price, and then assign whatever is left to the remaining performance obligations.
The fifth step is the actual recognition of revenue, which happens when the customer gains control of the goods or services, such as taking title, or accepting the goods, or when the seller has the legal right to be paid.
Additional Points
To deal with a customer’s right to return goods, the seller has to record an asset based on the right to recover products from any customers who have demanded a refund. So, this is an accrued asset, where the offset is a reduction of the cost of goods sold.
It is quite possible that the new standard will not impact the accounting for many organizations at all, especially retailers.
To deal with the new standard, be very consistent with your contract terms; otherwise, you will need to do a separate revenue recognition analysis for each contract. Also, be very precise about the wording used for performance obligations in the contracts, so there is no question about when an obligation has been completed. In addition, only analyze changes in variable consideration at longer intervals, in order not to waste too much time on it. And finally, create a system for documenting standalone selling prices, which makes it easier to allocate prices to individual performance obligations.