Excuse me if this is a bit too much “accounting talk”, but I believe this is something that will affect your business. Particularly those in software development.
The Financial Accounting Standards Board and the International Accounting Standards Board issued Revenue from Contracts with Customers in late May 2014. The new revenue recognition standard is principles-based, which is a big shift from and eliminates the industry-specific guidance under U.S. Generally Accepted Auditing Principles (GAAP) we have today. The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled.
To accomplish this objective, the standard requires five basic steps:
(i) identify the contract with the customer,
(ii) identify the performance obligations in the contract,
(iii) determine the transaction price,
(iv) allocate the transaction price to the performance obligations in the contract, and
(v) recognize revenue when (or as) the entity satisfies a performance obligation.
Every entity’s daily accounting and the way it executes contracts with customers might be affected. Entities will generally be required to make more estimates and use more judgment than under current guidance, which will be highlighted for users through increased disclosure requirements.
What is the timeframe for implementation? Non-public entities are required to apply the revenue recognition standard for annual reporting periods beginning December 15, 2017, and interim periods within annual periods beginning December 15, 2018. Non-public entities can early adopt for annual reporting periods beginning December 15, 2016.
Although the required implementation date for non-public entities is more than three years away, companies should start to prepare for this change soon to choose the most appropriate transition method.
Three basic transition methods are available:
- Full retrospective
- Retrospective with certain practical expedients
- Cumulative effect approach
Under the third alternative, an entity would apply the new revenue standard only to contracts that are incomplete under legacy U.S. GAAP at the date of initial application (e.g., January 1, 2017) and recognize the cumulative effect of the new standard as an adjustment to the opening balance of retained earnings. That is, prior years would not be restated and additional disclosures would be required to enable users of the financial statements to understand the impact of adopting the new standard in the current year compared to prior years that are presented under legacy U.S. GAAP.
Each transition option has pros and cons. It might be beneficial for your business to move from U.S. GAAP to the new Financial Reporting Framework for Small & Medium-Sized Entities.