Recently, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606). It replaces existing transaction- and industry-specific revenue recognition guidance with a principle-based approach. Public entities will be required to comply with the new standard for reporting periods beginning after December 15, 2016, and interim and annual reporting periods thereafter. Nonpublic entities will be required to comply for annual reporting periods on or after December 15, 2017, and interim reporting periods with annual reporting periods beginning after December 15, 2018.
The new standard applies to all contracts excluding leases and insurance contracts accounted for under other FASB standards; financial instruments; guarantees (other than product or service warranties); and nonmonetary exchanges between entities in the same business line to facilitate sales to customers.
Listed below are steps for applying this new standard.
Identify the contract with a customer.
For an entity to record a contract, the following criteria must be met:
a) Contract is approved by both parties (in writing, orally, or in accordance with other customary business practices), and both parties must be committed to perform their respective obligations.
b) Each party’s rights regarding the goods/services must be identifiable.
c) Payment terms for the goods/services must be identifiable.
d) Commercial substance must exist.
e) Collection is probable.
If a contract does not meet the above criteria and consideration (payment) is received from the customer, it is recognized as a liability until the following conditions are met:
a) All, or substantially all, of the consideration has been received, and no remaining obligations to transfer goods/services exist.
b) The contract is terminated, and consideration received is nonrefundable.
Identify the performance obligations in the contract.
A performance obligation is defined as a promise in a contract with a customer to transfer distinct goods/services. If the goods/services are not distinct, they will need to be combined as one performance obligation until the bundle is considered distinct.
Determine the transaction price.
Transaction price is the consideration amount an entity expects to receive in exchange for goods or services. When determining the transaction price, the effects of the following should be considered:
a) Variable consideration.
b) Constraining estimates of variable consideration.
c) The existence of a significant financing component.
d) Noncash considerations.
e) Consideration payable to the customer.
Allocate the transaction price.
When a contract contains more than one performance obligation, the transaction price is allocated based on the consideration the entity expects to receive in exchange for each separate performance obligation. Any changes in the transaction price or refunds should be proportionally allocated to the performance obligations.
Recognize revenue when or as the entity satisfies a performance obligation.
When a customer has the ability to direct the use of, and obtain substantially all of the remaining benefits from the asset, control has been transferred and the entity may then recognize the revenue. If the contract has more than one performance obligation, revenue will be recognized over time if one of the following criteria is met:
a) The customer receives and consumes the benefits as the entity performs.
b) The entity’s performance creates or enhances an asset that the customer controls as the asset is created or enhanced.
c) The entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date.
If you have questions about the revenue recognition changes in this ASU, contact the expert listed below at PYA, (800) 270-9629.