Digging deeper into challenges with the revenue recognition standard, companies find they are walking through a minefield when determining how to recognize costs associated with generating revenue.

As the Financial Accounting Standards Board developed its comprehensive new rule on revenue recognition to replace hundreds of historical accounting pronouncements, preparers began chirping about historic cost-tied-to-revenue guidance that would go away, leaving a potential void in the accounting rules. The new rule takes effect for public companies in 2018, and by many accounts companies are behind where they should be in preparing for the new accounting.

Yes, it’s a standard about revenue, not expenses, but the new rules contain some marching orders about how to write off expenses directly tied to generating revenue. That includes any cost associated with getting a contract, or any costs associated with fulfilling a contract.

Consider sales commissions, for example. That is a cost a company would incur if not for winning a particular contract. In terms of fulfillment, think of any start-up costs a company might incur to ready itself for a new customer or project—like new software or equipment it might need specifically to satisfy the obligations of a new contract.

“The cost guidance got added at the end of the whole process at the request—even demand—of constituents,” says Eric Knachel, senior consultation partner at Deloitte. “It did not get the full vetting and certainly was not intended to be fully comprehensive in terms of providing cost guidance.”

Historically speaking, a lot of the existing guidance on revenue recognition contains guidance on how to run off the costs associated with that revenue, and it typically is geared toward closely matching costs with revenue. As revenue is recognized, the costs associated with generating that revenue also are recognized.

“We’re definitely encouraging companies to focus on the cost aspects in addition to the revenue. This has been a little bit of a sleeper issue, but like revenue, you need processes and controls around it to account for it appropriately under the new standard.”
Dusty Stallings, Partner, PwC

The new guidance, however, is more focused on balance sheet recognition than on the matching of revenue and costs, says Dusty Stallings, a partner at PwC. “All that guidance that allowed for matching is gone, so now you have to look at it through a new lens,” she says.

That new lens is a little foggy for some, however, because of the guidance that vanished and the manner in which it was replaced. “The new standard eliminated some, but not all, of existing cost guidance, and then it introduced some new guidance,” says Knachel. “It’s a scoping issue, and it’s very confusing.”

FASB and its Transition Resource Group addressed cost guidance questions and offered some insights with respect to whether companies should apply historic guidance that still exists elsewhere in GAAP, says Knachel. The word given to companies was to apply historic guidance when a company’s particular accounting facts and circumstances were directly within the scope of old guidance. If not directly within the scope of old guidance, then new guidance should apply.

“That introduces a new challenge,” says Knachel. “Was I applying the old literature by analogy? Or was I directly in the scope of the old literature? The bottom line is there’s a real scoping issue that companies are wrestling with.”

The new guidance is clear that any incremental costs a company incurs to obtain a contract or fulfill a contract that are expected to be recovered over time must be treated as assets, not direct expenses. Sales commissions represent the most common example.

Any salary paid to a sales person, for example, is an expense incurred regardless of whether the company wins any particular contract. Any commission, however, is a cost clearly tied to a specific contract or transaction that the company will recover over the life of the arrangement. That means salary is an expense recognized as incurred, but the commission is an asset.

When a commission is treated as an asset, it’s added to the balance sheet as an asset and capitalized, or amortized, over the expected period of benefit of the contract. Even under historic GAAP, companies sometimes treat such costs as assets to be capitalized, but not always. Practice has been mixed in this area historically.


There are three major issues for companies to explore to assure they have considered the cost aspects of the new revenue recognition standard, according to Eric Knachel, senior consultation partner at Deloitte:
Scope — With some guidance replaced and some new guidance added, do you know which guidance to apply to determine how to account for the costs you incur to generate revenue?
What to capitalize — Do you know which costs must be capitalized and which should be accounted for as normal business expenses? Have you considered both costs to generate contracts and costs to fulfill contracts?
Amortization schedule — Do you know over what period of time to write down or amortize capitalized costs associated with generating revenue?
Source: Deloitte

While the new capitalization concept may sound straightforward enough, it’s not, says Knachel. If the contract contains renewals, if the commission rates might vary for any number of reasons, if employment terms are attached to commissions—all of those can affect how much of any given commission should be capitalized.

If compensation criteria for sales supervisors are somehow tied to commissions, that adds yet another layer of complexity, says Stallings. And long-term contracts at transition to the new standard may be tricky if commissions have not been tracked historically with the level of data detail now needed under the new standard.

In fact, the difficulty with the costing guidance may be inspiring some companies to change their adoption method says Phil Santarelli, a partner at audit firm Baker Tilly. Companies are required to adopt the standard using either a full retrospective method, restating historical information to provide three complete years of financial data under the standard, or a modified retrospective method, which leaves historic data as originally reported and relies on cumulative adjustments and disclosures to provide the historic perspective.

“We’ve heard anecdotally some industries with long-term contracts were considering the full retrospective method but had trouble tracking down commissions,” says Santarelli. “So that may be driving some companies to do the modified retrospective method so they don’t have to do a lot of backward looking.”

Deciding what fulfillment costs to capitalize is a little more foreign to companies. “Most companies have been expensing fulfillment costs as they go,” says Lynne Triplett, a partner at Grant Thornton. Companies need to take a careful look at their operational costs and determine exactly which costs they are incurring to set up for new contracts, as it might need to be capitalized rather than expensed.

Once identifying what must be capitalized, then companies have to determine over what period they need to amortize or write down those assets, says Triplett. Generally speaking, the amortization period should correlate with the life of the arrangement, or the time over which the customer is benefitting from the arrangement. Just as it can be complicated to determine the life of an arrangement when there are renewal options and other complexities to the contract time line, determining the amortization period can get complicated as well.

It also leads to questions about how to handle long-duration arrangements, says Triplett. Does it really make sense to amortize a sales commission over 20 or more years? “Many have concluded that’s an excessive time period to run that asset out off the balance sheet,” says Triplett. “However, coming up with the time period between there is a judgment.”

Especially with contracts that involve technology arrangements—where companies will have to arrive at conclusions based on the life of a particular product, not to mention renewals and upgrades—judgments are hard to establish, hard to support, and hard to audit.

And then there’s the impairment exercise companies will face in future periods by putting an intangible asset on the balance sheet. But that’s an accounting conundrum for another day, says Triplett.

“We’re definitely encouraging companies to focus on the cost aspects in addition to the revenue,” says Stallings. “This has been a little bit of a sleeper issue, but like revenue, you need processes and controls around it to account for it appropriately under the new standard.”