News & Insights > What Private Companies Should Know When Adopting the New Revenue Standard

What Private Companies Should Know When Adopting the New Revenue Standard

Although calendar year-end companies are required to adopt the new Revenue Recognition standard (ASC 606) as of the beginning of this year, many have deferred implementation activities until nearer to their financial reporting deadlines. While understandable, preparing well in advance for the switch is critical as developing and executing an implementation plan will likely require more time than anticipated.

 

At a High Level

The impact of the new standard is not limited to a quantitative change to the financial statements. Rather, the effect extends to areas including employee compensation, sales and contracting, tax, and information technology systems. Private companies should start by identifying revenue streams and grouping contracts with similar terms to gain a preliminary view on the impact to the company. Identifying stakeholders within these and other impacted areas and involving them in the adoption process early is integral to success. Even if results are not expected to significantly change, management will likely need to spend substantial time and effort to validate that conclusion.

All of the new accounting guidance applies to private companies and needs to be evaluated fully, consistent with adoption efforts at public entities. The primary difference between public and private company adoption efforts is limited to disclosure requirements. Although private companies can make certain elections to ease the burden of the new disclosure requirements, several new disclosures for private companies are required that may necessitate new processes to collect and organize the appropriate data.

 

Adoption Timing

Although private companies are required to adopt the new standard for fiscal years beginning after December 15, 2018, for those entities that report interim results, the standard is effective for quarterly reporting within fiscal years beginning after December 15, 2019. If choosing to adopt for quarterly reporting purposes in 2020, management should consider the challenges of preparing comparative interim financial information.

Specifically, if adoption efforts are deferred until late in 2019 or early 2020, management will need to evaluate contracts and transactions retrospectively, sometimes over a year after these transactions have taken place. This approach will create inefficiencies that may be avoided if adoption efforts are undertaken earlier during the required year of adoption.

 

Common Accounting Challenges

Identifying Performance Obligations

Determining whether specific promises within a contract represent separate performance obligations or should be combined into a single performance obligation can be difficult and, importantly, have downstream revenue impacts.

To properly identify performance obligations, companies need to assess whether a good or service is distinct, which will require consideration of the specific customer contract. Management should not assume that a specific good or service will be distinct if it is separately stated and priced within a contract. Rather, management should hold discussions with the sales and marketing department and others who engage with the customer to obtain a complete understanding of the nature of the deliverable.

Variable Consideration

An entity must determine the transaction price for each contract, including any estimate for variable consideration to which it will be entitled. Variable consideration is common and takes various forms, including, but not limited to, discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, and royalties. Consideration is also considered variable if the amount the company will receive is contingent on a future event occurring, even if the amount the company will receive is fixed.

Under the new standard, a company will only include variable consideration in the transaction price to the extent that it is probable that a significant reversal of revenue will not occur when the uncertainty is ultimately resolved. This determination can involve significant judgment and may significantly change practices for many companies. Therefore, depending on the company’s business practices, it will be important to identify the appropriate parties who can inform this decision, which may include individuals in operations, legal, sales, or manufacturing to understand all possible types of variable fees included in contracts or inherent in business practices.

If a contract includes variable consideration, management will need to update its estimates throughout the term of the contract to appropriately reflect circumstances that exist at each reporting date.

Principal Versus Agent

If more than one party is involved in providing goods or services to a customer, management must assess whether the nature of the promise is to provide the good or service itself (i.e. company is principal) or to arrange for the good or service to be provided by another party (i.e. company is agent). This assessment determines whether revenue is presented based on the gross consideration received from customers (principal) or net of amounts paid to a third party (agent).

The new guidance on principal versus agent considerations is similar to legacy accounting, with the key difference being the focus on control of the goods or services. Companies must first evaluate who controls the good or service before considering the indicators that a company is acting as principal. Companies will need take a fresh look at previous conclusions and review contract terms that may have an influence on the assessment of control. This analysis could result in reaching different conclusions under the new standard, and thus a change in income statement presentation.

Contract Costs

Certain costs to obtain and fulfill a contract are recognized as assets under the revenue standard. Incremental costs to obtain a contract—costs that would not have been incurred if the contract was not obtained, such as sales commissions—must be recognized as an asset if they are expected to be recovered. Similarly, costs to fulfill a contract, such as initial set-up or mobilization costs, should be recognized as an asset if the costs relate directly to the contract, generate or enhance resources of the company to use in satisfying future performance obligations, and are recoverable. Costs that are in the scope of other applicable guidance, such as inventory or internal-use software, will continue to be accounted for under those standards.

Specific challenges related to the evaluation of contract costs under the new standard include using judgment to determine if costs qualify for capitalization. For example, companies will need to determine whether fulfillment costs truly generate or enhance resources of the entity to satisfy future performance obligations, or whether these costs are incurred to satisfy performance obligations themselves (i.e., transfer control).

 

Disclosures

Under current guidance, revenue disclosures are generally limited. However, the new standard requires significant quantitative and qualitative disclosures aimed at providing financial statement users with an increased understanding of the nature, amount, timing, and uncertainty of revenue. As many of these disclosures were not previously required, new processes will likely need to be established to obtain and review the data required to address the new requirements.

While companies frequently address the preparation of financial statement disclosures at the end of the annual close process, given the incremental disclosures as a result of the new standard, companies should begin to consider how their financial statements will be impacted by ASC 606 at the beginning of the implementation process in order to evaluate and collect the proper data and ensure all stakeholders agree on areas of judgment.

Additionally, public companies are required to prepare more disclosures than private companies. Therefore, when evaluating best practice public competitor benchmarks, private companies should consider that certain elections can be made to eliminate some disclosures.

 

Lessons Learned from Public Companies

The experiences of public companies can be instructive as private companies navigate the implementation of the new standard. Below are some lessons learned from the public company adoption process:

  • Robust project management and early auditor involvement are integral to success. Boards and audit committees will want to see project plans that consider the broad impacts of the standard on the organization.
  • The implementation will affect functional areas outside of accounting. As such, companies should be mindful of IT, legal, tax, and sales both when determining how the standard impacts operations as well as when conducting employee training on the new standard.
  • Changes in revenue recognition may impact period over period comparisons as well as forecasts and targets. Although the financial statement impact is commonly the focus of adoption efforts, changes can impact periodic operational reporting, employee compensation targets, bank covenants, and other such areas that rely on financial reporting data.
  • The financial close process will likely be impacted by the new standard. Companies should consider the new data requirements for the updated disclosures early in the implementation timeline.

Summary

Private companies should not underestimate the time and resources needed to properly assess and implement the new guidance. Companies should start by creating an inventory of contracts currently in place and processing, at minimum, a sample of contracts through the lens of the new standard. Experience indicates that companies that address this challenge early on, will experience a more efficient and successful implementation.

 

How Riveron Can Help

Riveron’s business advisory specialists are hands-on partners, working together with you to sort through the details of adopting ASC 606 and the impacts on your organization.


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