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10 Things You Should Know About the New Revenue Standard

Scott Taub | July 22, 2014

At long last, we finally have a new accounting standard on revenue recognition.

It’s comprehensive, converged, and principles-based. This standard has been a long time coming, and it might well be the most significant improvement in global financial reporting we’ve seen or will see in a long time. There has already been much written about this standard, and there will be plenty more said—some, no doubt, by me—in the next two-and-a-half years until public companies start adopting it. But for now, here are 10 things you should know about the new standard.

1.  It’s not as long as it looks.

This is the longest standard FASB has ever issued. Some have used the length as proof that more time is needed before implementation. Others are just lamenting how difficult it’ll be to digest or wondering how a 700-page book can actually simplify the accounting literature on revenue recognition, which is part of the promise of the project.

But the 700 pages includes the 200-page “Basis for Conclusions” and 350 pages of conforming amendments to other parts of the Accounting Standards Codification that reference the revenue recognition literature. The actual guidance is only about 150 pages, covering the addition of Topics 606 and 610 on revenue and gain recognition to the ASC, as well as Sub-topic 340-40 on costs-of-revenue transactions.

The current revenue guidance in Topic 605 takes up over 200 pages, with industry-specific guidance that is also being replaced covering another 150 or so. So there is a significant reduction in the length of the guidance. I’m pretty sure we can all handle reading 150 pages without much trouble.

2.  It’s more comprehensive than what it replaces.

Despite less words, the new standard provides more guidance. A short list of areas that we will have guidance on in 2017 that aren’t in the codification today includes:

  • Contract modifications
  • Changes in estimates of contract life, transaction price, level of effort, and deliverables
  • Costs of revenue transactions
  • Service revenue recognition
  • Intellectual property deliverables other than software, motion pictures, and a few others that are currently addressed
  • Loyalty programs
  • Balance sheet presentation
  • Disclosures

I anticipate far less occasions with the new standard where I’ll have to explain a revenue issue by starting out with “Well, this isn’t covered in GAAP, but here’s how practice generally deals with it …”

3.  On balance, this standard will lead to earlier revenue recognition.

This effect is attributable to two particular concepts that underlie the guidance. First, FASB and IASB decided that control was the key concept in evaluating completion of performance obligations. This led to a determination that when work was being done solely to support a particular contract, revenue could potentially be appropriate even though the product wasn’t done. It also led to the conclusion that once products were delivered, retention of risks generally needn’t stop revenue recognition.

Second, the accounting boards recognized that existing revenue recognition literature looked at uncertainty in a very one-sided way, with any uncertainty counted against a company in revenue recognition unless there was specific guidance. This led to, for example, the prohibition on recognizing revenue that isn’t “fixed or determinable” and limitations on recognizing revenue in software deals with extended payment terms or undelivered items without vendor-specific objective evidence(VSOE) of fair value. The new standard removes some (but not all) of that conservative bias, generally allowing reasonable estimates of the outcomes of uncertain fees, performance obligations, and other matters.

4.  The cost of better guidance is more judgment.

The “fixed or determinable” and VSOE restrictions made it easy to figure out how much revenue to book in a lot of situations—zero. Reporting companies rightfully complained that these restrictions produced unnecessarily biased reporting in some situations. The new standard largely corrects this, allowing revenue to be recorded based on estimates so long as the effect of booking revenue based on those estimates is unlikely to lead to a revenue reversal in the future.

Thus, judgment will be necessary. Even if it wants to, a company can’t just adopt a policy of recognizing no uncertain revenue until the uncertainty is resolved.  Instead, the company must consider whether there is some amount that has a probability of being received. So, revenue reporting will better reflect economics, but it may well take more work for reporting companies.

5.  The accounting for the vast majority of transactions will remain the same.

I would guess that the accounting for upwards of 95 percent of transactions will have no changes. Accounting for simple retail product and service transactions, for example, will almost certainly not change. Most business-to-business transactions will also be accounted for the same way as under current guidance. Even some more complicated transactions like software with post-contract support and some percentage of completion contracts will have no change in accounting. On issues like rights of return and warranties, the new guidance is almost the same as the old. So don’t assume that everything, or even many things, will change.

6.  A significant portion of companies, however, will see a change.

While the accounting for the vast majority of transactions won’t change, I would guess that around half of all companies will have substantive changes in their accounting. For many of those companies, the changes will affect a small subset of transactions, while for others, there will be wholesale change. So, while concerns that everything is changing are unwarranted, there’s a pretty good chance your company will be affected somewhat.

7.  The requirements to recognize the time value of money are much ado about nothing.

The new standard requires companies that embed lending arrangements in a revenue transaction to recognize the financing component separately. But there’s a practicality exception so long as the difference between payment and performance is less than a year, and there is also acknowledgement that sometimes the reason for odd payment terms is not financing. Given the exceptions, I don’t think anybody will be recognizing interest income or expense because of this standard except when financing truly is an element of the transaction. And nobody should really be upset about that.

8.  Disclosures will change for almost everybody.

Disclosure requirements in current GAAP for most revenue transactions are almost nonexistent. The SEC’s attempts to elicit better revenue disclosure over the years have been partially successful, at best. The new standard requires a significant amount of disclosure. Some will believe it’s too much, but it’s hard to argue that revenue disclosures shouldn’t be as detailed as disclosures about fair-value measurements, pension plans, and other topics, given the importance of revenue to understanding what’s happening in any company. Even if you don’t have to change your accounting, you probably will be increasing your revenue disclosures.

9. The SEC’s disclosure requirements for new standards not yet adopted are no big deal.

The SEC requires registrants to disclose the anticipated effects of standards that have been promulgated but not yet adopted. I’ve heard many say that these requirements are a significant concern. I don’t get it. The requirement is to disclose what you know about the effects. There is no requirement to figure out the effect any faster than you otherwise would.

It’s easy to comply with SAB 74. Just tell readers what your status is, what you’ve figured out, and what you haven’t. A few hours when you prepare your 10-K and 10-Qs is all it’ll take. The only thing not to do is the thing that some companies insist on doing, which is to say “We don’t know how it’ll affect us” unless they have everything nailed down. Doing that blows away the whole intent of the disclosure requirement, so don’t fall into that trap. Just write a few sentences about what you know so far and what you don’t yet know. Worry about stuff that might actually be difficult to do. 

10.  It’s premature to ask for a delay in the adoption date.

Talk of an extension started before the standard was even issued. In part, this happened because it took FASB and IASB several months longer to issue than everybody had expected. In part, it’s because the issued document is 700 pages. In part it’s because it affects everybody. But none of that was a surprise.

Some have said that they need an extension because they want to adopt retrospectively. But FASB and IASB allowed a cumulative effect alternative specifically because they were told that requiring retrospective adoption was overly burdensome and unfair. It seems inappropriate to delay the whole standard because some have decided they want to do what they told FASB not to make them do.

It may well turn out that there are parts of the standard that are difficult to understand and implement, and that clarifications will be needed that might cause a need for a delay. It’s a big area and lots of questions are sure to arise. But to starting asking before any analysis is unfair and risks taking focus away from actually analyzing the effects of the new standard. Two-and-a-half years is a long time—longer that we’ve been given to adopt just about any standard in the past, and we’ve always gotten those done. I suspect that we can do this one as well, and if not, there will be enough time a year from now to talk extension. How about we table the discussion until then?