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Will New Revenue Standards on Customer Contracts Impact You?

Posted by JAMIS Software on June 28, 2016

accountingU.S. Generally Accepted Accounting Principles (GAAP), as codified in the Accounting Standards Codification, does not provide one, all-inclusive general standard on revenue recognition that applies across the board to all transactions and entities. Companies follow various subtopics in the Codification or industry specific standards to determine the proper procedures for recognizing revenue. That will all change for contracts with customers once new revenue recognition standards go into effect.

In May 2014, the International Accounting Standards Board (“IASB”) and Financial Accounting Standards Board (“FASB”) issued new requirements on recognizing revenue that derives from customer-based contracts. These new standards will impact any company operating under GAAP or under the International Financial Reporting Standards (IFRS). This change to revenue recognition has particular implications to government contractors. While the effective date of these changes continues to be postponed, it is still important for government contractors to be aware of the changes coming and to start thinking about how your company will be impacted.

The new standards were issued under Accounting Standards Update (ASU) Number 2014-09, Revenue from Contracts with Customers (Topic 606). It is a common understanding within the accounting profession that the FASB and IFRS differ in multiple areas. As part of the convergence between the two, accounting standards are being updated to remove inconsistencies and clarify principles for common criteria between the two. With few exceptions, the U.S. GAAP standards relating to revenue recognition will closely resemble IFRS as a result of the joint effort of the FASB and IASB.

ASU 2014-09 affects any entity that either enters into contracts with customers to transfer goods or services, or enters into contracts for the transfer of nonfinancial assets (unless those contracts are within the scope of other standards, such as insurance or lease contracts). The principle behind the change in standard is to ensure companies recognize revenue in an amount that reflects the consideration (i.e. the payment) by which the company expects to be entitled to in exchange for the goods or services provided. This amount should be determined by following five steps:

  1. Identify contract(s) with a customer.
  2. Identify the performance obligations in the contract.
  3. Determine the transaction price.
  4. Allocate the transaction price to the performance obligations in the contract.
  5. Recognize revenue when (or as) the company satisfies a performance obligation.

The new standards also require enhanced disclosures about revenue, such as contract balances and remaining performance obligations, as well as guidance on recognizing revenue on transactions such as on contract modifications.

The effective date for implementing ASU 2014-09 was subsequently delayed by one year in response to stakeholders’ requests to provide sufficient time to successfully implement the guidance. Currently, the effective dates for applying ASU 2014-09 starts on annual reporting periods beginning after December 15, 2017, for public companies, and on annual reporting periods beginning after December 15, 2018, for nonpublic entities. Cherry Bekaert is not trying to sound any alarms as these dates could be pushed further out still, but we do want to make sure you are aware of these changes.

Between the changes to recognizing revenue to the new disclosure requirements, just about every government contractor will be impacted in some form or another by this new standard. For some companies, the change will be minimal and business as usual from an accounting perspective. For others, however, management will be faced with making new calculations, judgments, estimates and disclosures. Conducting an assessment of the impact to your company will help you to determine what gaps, if any, exist in your information that will have to be filled through process or system changes.

For example, do your contracts clearly define when the control of the goods or services transfers to the customer? The key to the new recognition principle will focus on the transfer of control to the customer, not the transfer of risks and rewards. Furthermore, the transfer of control may be satisfied at a ‘point in time’ or ‘over time.’ Unless the reporting entity can show the performance obligation is satisfied over time, the default will be point in time. Where a company might be able to currently defer revenue, the new standard might require an acceleration. An example would be for a manufacturer who produces goods to a customer’s specification; this company may be required to recognize the revenue as the goods are produced, not when they are delivered, because the performance obligation has been satisfied.

Another major change concerns constraints on revenue that applies to variable considerations, such as rebates, refunds, credits and incentives. Current GAAP requires that consideration be fixed or determinable in order to be recognized. Under the new standard, any variable consideration will need to be estimated and updated at each reporting date, subject to an applied constraint unless there is sufficient evidence or experience to support that a revenue reversal is not realistic. This could have implications on Incentive based or Award Fee based contracts.

As a result of feedback received from stakeholders preparing to implement the guidance in ASU 2014-09, the FASB has exposed a Proposed Update addressing improvements in certain technical areas and providing practical expedients. Contact our partners at Cherry Bekaert GovCon or  an audit professional to start discussing how these changes will impact you.

There isn’t accounting software that will change the new standards facing government contractors. But there are efficient business and accounting systems that have been specifically designed to ease the process. To find out more about how JAMIS Prime can help your business, contact us today at info@jamis.com or join our next monthly webinar.

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