Starting in 2018 for public companies and 2019 for other entities, revenue must be reported using the new principles-based guidance found in Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. The updated guidance doesn’t affect the number of revenue companies report over the life of a contract. Rather, it affects the timing of revenue recognition.
The purpose of this change is to converge with the International Accounting Standards Board (IASB). The goal is to remove numerous inconsistencies between the FASB and IASB revenue recognition standards. These changes require entities, including not-for-profits, to clearly identify performance obligations in existing contracts, reapportion revenue at each contract revision or change and defer expense recognition to match with the contract’s delivery. With this being the case, contract add-ons and contract renewals must be aligned into a single contract and will prompt reallocations across both past and future periods – which can cause numerous revisions to revenue allocations and expense alignment.
With over 200 revenue recognition standards in the United States, the new principle-based standard focuses on the contract between the entity and consumer for the agreement of services or goods, and it also focuses on the rights and duties between the two parties.
Earnings before interest, taxes, depreciation, and amortization (EBITDA) will be changing as well. This is because the “right to use” asset that is set for the lease is amortized over the lease term. This changes it from an operating expense to a reduction of lease obligation while amortization expenses are recorded to reduce the right to use the asset.
Generally, leases will be on the balance sheet, and it is important to remember that leverage ratios will be changing and liabilities will be increasing. For some entities, this change will be extraordinary. For example, if a company has $500 million in liabilities and $500 million in equity and $200 million in future operating lease obligations, then they would have a leverage ratio of 1:1. In this example, when leases are recorded as a liability on the balance sheet, the leverage ratio would go to 1.4:1, which is a substantial change.
When it comes to revenue, auditors customarily watch for fictitious transactions and premature recognition ploys. Here’s a look at some examples of critical issues that auditors may target to prevent and detect improper revenue recognition tactics.
Considering the new revenue recognition standard, companies should expect revenue to receive renewed attention in the coming audit season. Contact us to help implement the new revenue recognition rules or to discuss how the changes will affect audit fieldwork.
Some recommended steps for businesses to evaluate the ramifications of the new revenue recognition standards are:
At LBMC Technology Solutions, we understand that navigating through these changes can be a monumental task. This is why we provide solutions that are automated, enabling companies to both manage revenue using current and new guidelines simultaneously. Our programs can offer you the ability to:
