To be compliant with US Generally Accepted Accounting Principles (GAAP), private companies will need to adopt the new revenue recognition guidance (Topic 606, Revenue from Contracts with Customers) in 2019. As an update to the current status of the amended requirements, the following summarizes the guidance included in several Accounting Standards Updates (ASUs) issued in 2016:
Principal versus Agent Considerations (Reporting Revenue Gross versus Net)
The amendments relate to when another party is involved with an entity in providing a good or service to a customer. The entity must determine whether the nature of its promise is to provide (as a principal), or arrange to provide (as an agent), that good or service to the customer. The determination is based on whether control is obtained by the entity before it transfers the good or service to the customer. When this occurs, the entity is a principal and should report revenue gross. An entity that is a principal obtains control of:
- a good or another asset from the other party that it then transfers to the customer;
- a right to a service that will be performed by another party, which gives the entity the ability to direct that party to provide the service to the customer on the entity’s behalf; or
- a good or service from the other party that it combines with other goods or services to provide the specified good or service to the customer.
Indicators and application guidance are provided to determine control. The assessment must include each specified good or service promised and the nature of each (a good, a service, or a right to a good or service).
Identifying Performance Obligations
An entity must first identify the promised goods or services in a contract before it can identify its performance obligations. To identify performance obligations in a contract, an entity evaluates whether promised goods and services are distinct. Topic 606 includes an amendment to determine whether a promise is distinct, one being that it is separately identifiable. Determining whether a promise is separately identifiable is primarily based on whether the nature of a promise in a contract is to transfer each of the goods or services or to transfer a combined item(s) to which the promised goods and/or services are inputs. Additional amendments include:
- There is no requirement to assess goods or services that are immaterial in the context of the contract.
- Shipping and handling activities occurring after the customer has obtained control of a good can be accounted for as an activity to fulfill the promise to transfer the good, rather than as an additional service.
Licensing
A promise to grant a license provides a customer with either a right to use the entity’s intellectual property (which is satisfied at a point in time) or a right to access the entity’s intellectual property (which is satisfied over time). Amendments are as follows:
- A promise to grant a customer a license to intellectual property that has significant stand-alone functionality does not include supporting or maintaining that intellectual property during the license period.
- A promise to grant a customer a license to symbolic intellectual property (does not have significant stand-alone functionality) includes supporting or maintaining that intellectual property during the license period.
- An entity considers the nature of its promise in granting a license, regardless of whether the license is distinct, in order to apply the other guidance to a single performance obligation that includes a license and other goods or services (whether a performance obligation is satisfied at a point in time, or over time, and how to measure progress).
Technical Corrections, Narrow-Scope Improvements and Practical Expedients
- The evaluation of the collectibility criterion is based on the validity of the substance of a contract as well as the customer’s ability and intention to pay for transferred goods or services.
- Entities can elect to exclude sales taxes collected from customers from the transaction price.
- The measurement date for noncash consideration is contract inception and the variable consideration guidance applies only to variability resulting from reasons other than the form of the consideration.
- A practical expedient permits an entity to reflect the aggregate effect of all modifications that occur before the beginning of the earliest period presented.
- A completed contract for purposes of transition is a contract for which substantially all of the revenue was recognized under legacy GAAP before the date of initial application. Application of the modified retrospective transition method either to all contracts or only to contracts that are not completed contracts is permitted.
- The disclosure of the effect of the accounting change is not required for the period of adoption when the retrospective application guidance is applied to each prior period; however, the disclosure of the effect of the changes on any prior periods is still required.
- Specific technical changes include loan guarantee fees, contract costs, provision for losses on construction- and production-type contracts, clarifications and options for disclosures, scope clarifications, examples and references.
The new revenue recognition requirement is quickly approaching. Planning for proper implementation takes time and there are retroactive accounting and disclosure requirements to consider for prior periods. For questions, more information or assistance with implementation, please contact Jeff Parsell at jparsell@windes.com or 844.4WINDES (844.494.6337).