Revenue Recognition:
Ten Top Changes to Expect
with the New Standard
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Lisa Starczewski
Buchanan Ingersoll & Rooney
Revenue Recognition: Ten Top Changes to Expect with the New Standard
Table of Contents:
Introduction
Ten Top Changes to Expect with the New Standard
1. Industry-specific guidance is out; thus, the new approach is more reliant on professional
judgment and contract terms and conditions.
2. The new rules will apply to all entities that enter into contracts with customers.
3. The key to revenue recognition under the new approach is the “transfer of control” of a
promised good or service (not the transfer of risks and rewards).
4. A single contract may contain a different number of separate performance obligations
than under current U.S. GAAP.
5. Collectibility is no longer a recognition threshold and does not affect the measurement of
transaction price.
6. The new guidance introduces a constraint on revenue that applies to variable
consideration (rebates, refunds, credits and incentives).
7. The rules for accounting for long-term contracts are changing.
8. The rules for accounting for licenses are changing.
9. All reporting entities will allocate the transaction price to the good or service underlying
each performance obligation on a relative stand-alone selling price basis.
10. For public entities applying U.S. GAAP, the new guidance will generally be effective for
annual reporting periods beginning after December 15, 2016, including interim reporting
periods therein. Early application is prohibited.
Conclusion
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Revenue Recognition: Ten Top Changes to Expect with the New Standard
After three years, two exposure drafts, over 1,300 comment letters and countless meetings and outreach
activities, the Financial Accounting Standards Board and International Accounting Standards Board (the
“Boards”) are within a few weeks of each issuing a new revenue standard. The main goals of the joint
revenue recognition project are relatively straightforward – convergence and consistency. There are
currently significant differences between U.S. Generally Accepted Accounting Principles and
International Financial Reporting Standards with respect to revenue recognition principles and, as stated
by Leslie Seidman, Chair of the FASB, “It’s important to have global comparability for the top line of
every company in the world.”
Current U.S. GAAP, as codified in the Accounting Standards Codification (ASC) does not provide one,
all-inclusive general standard on revenue recognition that applies across the board to all transactions and
industries. Instead, ASC 605-10 provides broad, conceptual guidelines and several other subtopics in the
Codification provide additional guidance that applies, by its own terms, to specific types of transactions
or industries. In some respects, therefore, the devil is currently in the details. The application of the
industry-specific detailed guidance in current U.S. GAAP often results in companies’ accounting
differently for transactions that are, in substance, economically similar. In addition, because the current
international standards provide fewer specific requirements, companies applying IFRS often pick and
choose specific U.S. GAAP guidance to fill in the holes.
Both soon-to-be-released revenue standards will contain a new principled approach to revenue
recognition that will apply to revenue from contracts with customers across all industries. The following
is a list of ten important pieces of information relevant to the anticipated changes to the revenue
recognition rules.
Lisa Starczewski
Buchanan Ingersoll & Rooney
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1. Industry-specific guidance is out;
how a reporting entity transfers value
thus, the new approach is more
(control of goods or services) to a customer.
reliant on professional judgment
The new guidance will also require an entity
and
to use estimates more extensively than under
contract
terms
and
conditions.
current GAAP.
The approach to revenue recognition is
2. The new rules will apply to all
changing. Once the new guidance is
entities that enter into contracts
effective, it will supersede the vast majority
with customers.
of the current industry-specific revenue
recognition
guidance.
industry-
Unless a contract is specifically excepted
specific guidance is out and a new, single
from application of the revenue standard
comprehensive model with foundational
(e.g., insurance contracts and leases), the
principles and objectives is in. Under current
new guidance will apply. Thus, all entities
U.S. GAAP, management and outside
will have to apply the new approach to
advisers are continually exercising judgment
revenue recognition and will be subject to
and analyzing contract terms in order to
expanded
determine the proper way to account for
However, the new rules will impact certain
transactions and events. However, in the
industries more significantly than others,
context of revenue recognition, they are able
particularly those that presently rely on
to rely on a significant body of industry-
industry-specific guidance. The impact,
specific
though, will not always be a deferral in
guidance
Thus,
to
aid
in
this
determination.
disclosure
requirements.
revenue recognition. In fact, in many cases,
revenue recognition will be accelerated.
The elimination of this industry-specific
guidance in favor of broad principles
necessitates greater reliance on professional
judgment, customary business practices and
specific contract terms. Thus, lawyers and
other advisers may play a key role in
drafting contracts to clearly define when and
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3. The key to revenue recognition
obligations are considered satisfied over
under the new approach is the
“transfer
of
control”
of
time.
a
promised good or service (not the
4. A single contract may contain a
transfer of risks and rewards).
different
number
performance
Under the new guidance, a reporting entity
of
separate
obligations
than
under current U.S. GAAP.
will recognize revenue when (or as) it
satisfies a performance obligation, which is
If a promised good or service is both
defined as the transfer of control of
“capable of being distinct” and “distinct
promised goods or services. A performance
within the context of the contract,” it will be
obligation may be satisfied at a “point in
considered
time” or “over time.” The new guidance will
obligation under the new rules. A good or
require a reporting entity to apply certain
service is “capable of being distinct” if the
criteria
particular
customer is able to benefit from the good or
performance obligation is satisfied over
service either on its own or together with
time. If a performance obligation does not
other resources that are readily available to
meet at least one of these criteria, the
the customer. A good or service is “distinct
performance obligation will be considered
within the context of the contract” if it is not
satisfied at a point in time.
highly
to
determine
if
a
a
separate
dependent
upon,
performance
or
highly
interrelated with, other promised goods or
In some cases, this new approach will affect
services in the contract (based on the
long-standing
application of a number of indicators).
patterns
of
revenue
recognition. For example, under the new
guidance, manufacturers of large volumes of
As an example, if a reporting entity provides
homogeneous
a
a service as part of a warranty in addition to
customer’s specification may be required to
assurance that the product complies with
recognize revenue as they produce the
agreed-upon specifications, the promised
promised units (in contrast to when they
service may (depending upon application of
deliver them) because the performance
the criteria) be considered a separate
goods
produced
to
performance obligation. A performance
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obligation may be explicitly stated in the
Under current GAAP, “reasonable assurance
contract or implied by an entity’s customary
of collectibility” is one of the four
business practices, published policies or
fundamental revenue recognition criteria. In
specific statements. Thus, a reporting entity
this context, collectibility refers to the
often will have to look beyond the terms of
customer’s credit risk (i.e., the risk that the
the contract to determine whether additional
reporting entity will be unable to collect all
performance obligations exist.
or a portion of the contract consideration).
Moreover, the new guidance eliminates the
Under the new guidance, assurance of
concept
objective
collectibility will not be a recognition
evidence (VSOE) as a separation criterion.
criterion and, for contracts without a
That is, under current U.S. GAAP, software
significant financing component, transaction
vendors often treat all of the promised goods
price will be equal to the amount of
and services in a software arrangement as a
consideration to which the reporting entity is
single element (and recognize revenue once
entitled – not the amount that the reporting
the last promised good or service is
entity expects to receive. Transaction price
delivered) because they are unable to
will not be adjusted for customer credit risk,
establish VSOE of fair value for one or more
but
of the elements. Under the new rules, this
receivables will be separately presented as
inability to establish VSOE of fair value will
an expense.
of
vendor-specific
rather,
impairments
of
customer
not preclude an entity from identifying
separate
performance
obligations in a
However, although collectibility will no
software arrangement and allocating a
longer be an explicit recognition criterion, it
portion of the transaction price to each
will still be an important concept in
obligation.
determining whether a contract exists and
thus will still be a relevant concept under the
5. Collectibility
is
no
longer
a
new guidance. If collectibility is in doubt at
recognition threshold and does
a contract’s inception, the reporting entity
not affect the measurement of
might conclude, depending on the level of
transaction price.
doubt and other facts and circumstances,
that the customer is not committed to
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perform its obligation under the contract. In
considers all of the facts and circumstances
that case, there would be no contract to
associated with both the risk of a revenue
which the new revenue standard applies.
reversal arising from an uncertain future
event and the magnitude of the reversal if
6. The new guidance introduces a
that uncertain event were to occur. This is
constraint on revenue that applies
one of the many determinations under the
to variable consideration (rebates,
new guidance that will require significant
refunds, credits and incentives).
judgment.
Under current U.S. GAAP, one of the four
7. The rules for accounting for long-
revenue recognition criteria requires that
term contracts are changing.
consideration be fixed or determinable in
order to be recognized. Thus, a reporting
In accounting for long-term contracts, under
entity (with limited exceptions) does not
current U.S. GAAP, most entities recognize
include variable amounts in the transaction
revenue by applying the percentage-of-
price until the variability is resolved.
completion
method
based
on
reliable
estimates. Under the new rules, in a longUnder the new guidance, if the promised
term contract, a performance obligation will
amount of consideration in the contract is
be considered satisfied over time only if
variable, a reporting entity will estimate the
certain criteria are met and revenue will be
total consideration to which it is entitled
recognized only when or as control of the
(using either the “expected value” approach
asset is transferred to the customer. Thus,
or the “most likely amount” approach) and
under the new approach, a reporting entity’s
update that estimate at each reporting date.
accounting for a long-term construction or
The reporting entity will apply a constraint,
production contract will be dependent upon
pursuant to which it will include variable
when and how control of the asset is
consideration in transaction price if it has
transferred to the customer under the terms
sufficient evidence or experience to support
of the contract.
its conclusion that the revenue recognized
should not be subject to significant revenue
reversal. This assessment is qualitative and
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8. The
rules
for
accounting
for
9. All reporting entities will allocate
licenses are changing.
the transaction price to the good
or
The new guidance will provide one standard
service
performance
approach to accounting for licenses that
underlying
obligation
each
on
a
relative stand-alone selling price
applies to all industries. Some licenses will
basis.
be accounted for as a promise to provide a
right while others will be accounted for as a
The “stand-alone selling price” is the price
promise to provide access to property. The
at which an entity would sell the good or
new guidance will likely accelerate revenue
service separately to a customer. The best
in cases in which a license is considered a
evidence of that price is the observable price
promise to provide a right and is a separate
of a good or service when the entity sells
performance obligation satisfied at a point in
that good or service separately to similar
time.
customers in similar circumstances. If the
good or service is not sold separately (the
In
addition,
the
pattern
of
revenue
stand-alone selling price is not directly
recognition may change significantly based
observable), the reporting entity estimates its
on application of the new constraint on
stand-alone selling price by considering
revenue and the fact the collectibility is no
market conditions, entity-specific factors
longer an explicit recognition threshold.
and information about the customer or class
Under the new approach, a licensor will
of customer and by maximizing the use of
recognize license revenue over time if (1)
observable
the license is a promise to provide a right or
consistently apply a suitable estimation
a promise to provide access but is not
method, such as the adjusted market
distinct and is, instead, bundled with
assessment approach, the expected cost plus
services that are being performed over time;
margin
(2) the license is a promise to provide
conditions, the residual approach.
inputs.
approach,
The
and,
entity
under
must
certain
access; or (3) the constraint on revenue
applies
and
requires
the
licensor
to
The
general
approach
to
determining
recognize all or a portion of the transaction
relative stand-alone selling price in the new
price as the variability is resolved.
standard is similar to, although not identical
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to, current U.S. GAAP. The most significant
10. For public entities applying U.S.
change is the fact that this approach applies
GAAP, the new guidance will
across all industries, including the software
generally be effective for annual
industry. Software arrangements will be
reporting periods beginning after
subject to the same rules as other contracts
December
with customers. Thus, in the context of a
interim reporting periods therein.
software
Early application is prohibited.
arrangement,
the
new
rules
15,
2016,
including
eliminate the requirement that a software
The IASB will require a public entity to
vendor allocate consideration based on
apply the revenue standard for reporting
VSOE of fair value. Under current U.S.
periods beginning on or after January 1,
GAAP, if a company does not have
2017 and is allowing early application.
sufficient VSOE of fair value to allocate
With respect to transition, entities will have
revenue to the various elements in a
a choice to either (a) apply the new guidance
multiple-element software arrangement, the
retrospectively, with or without applying
company must defer all revenue from the
certain practical expedients; or (b) apply the
arrangement until the earlier of the date on
new guidance pursuant to an alternative
which (1) the company has sufficient VSOE;
transition
or (2) the company has met the delivery
method
(with
no
required
restatement of comparative years). For
requirement with respect to all elements in
nonpublic entities, the new rules will
the arrangement.
generally be effective for reporting periods
beginning after December 15, 2017 and
The new guidance will likely accelerate
interim
revenue in many cases because companies
and
annual
reporting
periods
thereafter, although these entities may elect
that now have to defer revenue (because
to apply the requirements a year earlier.
there is no VSOE of fair value) will be able
to recognize revenue earlier.
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This list is by no means an exhaustive list of the anticipated changes to the revenue
recognition rules. It is, instead, a summary of the most significant changes that can be
used as starting point to understand the new approach and assess the impact of these
changes.
Companies should be assessing their current systems and processes to determine the changes that they
will need to make in order to comply with the new approach. IT systems will have to be updated in order
to properly capture revenue (in a systematic way) in the proper period. Companies must gain a detailed
understanding of the new rules in order to analyze existing contracts and models and determine what
changes will be applicable to them. Regulation S-X requires SEC registrants to disclose the effects of
published but not yet adopted accounting standards. In order to avoid stating that they have not yet
determined the effect of this very significant new revenue standard, companies will have to evaluate the
new standard and disclose the possible effects of the new standard’s approach to revenue recognition.
Once the new rules are finalized, companies, when drafting new agreements, should consider the new
approach and the impact it may have on specific types of transactions. Although the Boards plan to give
companies significant lead time before requiring application of the final rules, the time to analyze and
plan for their impact is now.
Lisa Starczewski
Buchanan Ingersoll & Rooney
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