Are You Keeping Up With All of the New Rules and Regulations?

New Rules for Revenue Recognition

Article written by EricBank

The guardian of U.S. generally accepted accounting principles, the Financial Accounting Standards Board (FASB), has been working for some time with its counterparts at the International Accounting Standards Board to harmonize their respective accounting guidelines. One result, which goes into effect in 2017, deals with revenue recognition for contract sales, whether the contract is written, spoken or a result of regular business practices.

The Five-Part Model

The new model describes in five steps the FASB rules for recognizing revenue. This is especially important for small businesses that often work without written contracts. Although the new rules cover most selling situations, a few contract types, such as those for leases and insurance, operate under different rules. Here is a summary of the FASB five-part revenue recognition model:

1.    Identify the Contract -- According to FASB, a contractual agreement between two or more parties specifies rights and obligations that are legally enforceable. The new GAAP rules apply separately to each contract, though under certain circumstances the parties can combine multiple contracts.

2.    Identify Performance Obligations -- Contracts contain one or more performance obligations, which are commitments to transfer from seller to customer specified goods and services. Under the new rules, you might be obliged either to combine multiple performance obligations or to account for each one separately. Sometimes, performance obligations involve third parties.

3.    Determine Transaction Price -- When a seller transfers goods or services, it expects the customer to pay cash or some other form of consideration. FASB gives four guidelines to help determine the price for a transaction:

.   You are to predict the most likely value if you need to consider multiple variables.

.   Take into account the time value of money, or interest.

.   Measure non-cash considerations at fair market value.

.   If the seller pays an inducement or offers a discount to the customer, reducethe transaction price accordingly. However, do not reduce the price because of uncertainty of payment -- there are other procedures for handling that.

4.    Allocate Transaction Price -- Use the standalone price, real or estimated, to allocate revenue and discounts among multiple performance obligations. If the contract price changes, update revenue as of the period of the change.

5.    Recognize Revenue -- The last step is to identify the point where a seller fulfills the obligation to transfer goods or services. There are two cases:

.   Transfers Over Time -- FASB gives a number of criteria that a seller should follow to recognize revenue when transfers occur over a period of time.

.   Transfers at a Point in Time -- There are five types of events that indicate the transfer has occurred, including the right to getting paid, the customer assuming legal title, and physically transferring goods from the seller to the customer or to a third party.

FASB also discusses special topics, such as repurchase agreements and consignment arrangements. Although the final implementation is a few years away, many companies are already planning for the new rules, and there is no prohibition against getting an early start.