Understanding New Revenue Recognition Standards
Revenue recognition standards, such as IFRS 15 and ASC 606, provide a consistent framework for recognizing revenue from contracts with customers. These standards are designed to improve comparability across industries and enhance financial statement transparency.
Core Principles of IFRS 15 and ASC 606
Both IFRS 15 and ASC 606 are built around a fivestep model for revenue recognition
1. Identify the Contract with a Customer
A contract is an agreement between two or more parties that creates enforceable rights and obligations.
Contracts can be written, oral, or implied by customary business practices.
2. Identify the Performance Obligations in the Contract
A performance obligation is a promise to transfer a distinct good or service to the customer.
Distinct goods or services are those that can benefit the customer on their own or together with other readily available resources.
3. Determine the Transaction Price
The transaction price is the amount of consideration to which an entity expects to be end in exchange for transferring promised goods or services.
Consideration may include fixed amounts, variable amounts, or both.
4. Allocate the Transaction Price to the Performance Obligations
If a contract has multiple performance obligations, the transaction price must be allocated to each performance obligation based on their relative standalone selling prices.
Standalone selling prices are the prices at which an entity would sell a promised good or service separately to a customer.
5. Recognize Revenue When (or as) the Entity Satisfies a Performance Obligation
Revenue is recognized when control of the good or service is transferred to the customer.
Control can be transferred over time or at a point in time, depending on the nature of the performance obligation.
Key Changes and Impacts
1. Timing of Revenue Recognition
The new standards may change the timing of when revenue is recognized compared to previous standards.
Companies need to assess each contract to determine the appropriate timing of revenue recognition.
2. Disclosures
The new standards require enhanced disclosures to provide better information about the nature, amount, timing, and uncertainty of revenue and cash flows from contracts with customers.
This includes disaggregated revenue information, contract balances, performance obligations, and significant judgments.
3. Variable Consideration
The new standards provide detailed guidance on estimating variable consideration and include constraints to ensure that revenue is not overstated.
4. Contract Modifications
The new standards offer specific guidance on accounting for contract modifications, which may be treated as separate contracts or as part of the existing contract.
Preparing for Compliance
1. Assess the Impact
Conduct a comprehensive assessment of how the new standards will affect your current revenue recognition practices.
Identify contracts that will be significantly impacted and quantify the potential changes in revenue recognition.
2. Update Accounting Policies
Revise your accounting policies to align with the new standards.
Ensure that all relevant personnel are aware of and understand the updated policies.
3. Train Staff
Provide training for accounting and finance teams, as well as other relevant departments, to ensure they understand the new standards and how to apply them.
4. Revise Contracts
Review and update customer contracts to ensure compliance with the new standards.
Work with legal advisors to make necessary changes to contract terms and conditions.
5. Enhance Systems and Processes
Upgrade your accounting systems and processes to handle the complexities of the new standards.
Implement software solutions that support the new revenue recognition rules and provide realtime visibility into revenue recognition.
6. Strengthen Internal Controls
Update internal controls to support compliance with the new standards.
Conduct regular internal audits to ensure controls are effective and being followed.
7. Communicate with Stakeholders
Inform stakeholders, including investors, auditors, and regulatory bodies, about the changes and their impact on financial reporting.
Provide clear and detailed explanations to maintain transparency and trust.
Understanding and complying with new revenue recognition standards like IFRS 15 and ASC 606 is crucial for accurate financial reporting and maintaining stakeholder trust. By following the fivestep model and preparing thoroughly, businesses can navigate these changes effectively and ensure compliance.