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October 1, 2018
In an effort to standardize how companies and industries recognize revenue, the FASB’s new 5-step framework provides a comprehensive, industry-neutral revenue recognition model intended to increase financial statement comparability across companies and industries.
All entities (public, private, and not-for-profit) that enter into contracts with customers must apply this new guidance, unless those contracts are within the scope of other standards (i.e. leases and insurance contracts).
Nonpublic entities reporting under US Generally Accepted Accounting Principles are required to apply the revenue standard for annual periods beginning after December 15, 2018.
The standard adopts a new 5-Step framework for recognizing revenue under contracts with customers:
1. Identify the Contract
This step requires management to determine what constitutes a contract with a customer. A contract exists when the following 5 criteria are present:
2. Identify Performance Obligations
Every contract will consist of one or more performance obligations, defined as a promise (explicit or implicit) to transfer distinct goods, services, or a series of goods or services that are substantially the same. All performance obligations must be identified at contract inception. Generally, a good or service is distinct if a customer is able to economically benefit from the good, service, or bundle in some way (i.e. use, consume, sell, or otherwise generate economic benefit).
3. Determine Transaction Price
The transaction price is the amount transferred or the amount an entity expects to receive for the transfer of goods and/or services. This may include fixed, variable and other noncash consideration, and will often require judgment.
4. Allocate Transaction Price to Performance Obligations
Allocation should be made to each separately identified performance obligation in a way that represents the stand-alone value (or estimated value) of each performance obligation. Changes in transaction price triggered by a contract modification will follow separate guidance.
5. Recognize Revenue when Performance Obligations are met, or as they are satisfied.
Revenue shall be recognized at a point in time, or over time, based on how and when a performance obligation is satisfied. This step hinges on determination of when control of the good or service is transferred to the customer. Transfer of control over the good or service will be measured using an input (i.e. cost, labor hours etc.…) or output (i.e. units produced) method that cannot be changed once selected.
Some companies will be impacted more than others—especially those under industry-specific guidance.
The time is now to prepare for these changes and assess your current processes in order to properly identify where action is required. Our team is hard at work developing industry-specific resources to aid you in this process. If you have questions, contact us at 217-351-2000 and ask for Katie Duval.