Revenue is one of the most important measures used by third parties in evaluating a company's performance and prospective endeavors. Previous guidelines for revenue recognition were inadequate and lacked consistency across industries and around the globe. In 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Codification (ASC) 606 with new rules for revenue recognition. The goal of the new standard is to simplify and create global cohesion between revenue recognition. This change is primarily to address the inconsistencies across industries between IFRS and GAAP. It will help close the gap in reporting methods and, by doing so, it will make reporting more comparable. These new accounting rules have been noted as the biggest change to accounting standards in the last century. FASB has been monitoring the gradual adoption of these standards over the last four years, but time has run out and all public companies are expected to make the leap by the end of 2018, with private companies to follow in 2019. Non-compliance with ASC 606 is a huge risk that could result in revenue recognition errors and force companies to issue earning restatements (Reddy, 2018).
This new guidance can be considered a major achievement in the effort to improve financial accounting. It has established principles that include a set of cohesive disclosure requirements that allow useful information from the financial statements to be relayed to users. This information could include certain aspects such as the nature, amount and timing of customer contracts. ASC 606 provides a stronger framework for addressing revenue issues and removes inconsistencies within existing revenue requirements. Overall, it works to align revenue recognition practices across the entities and markets while simplifying financial statement preparation. Some may pose questions about how this new standard will affect GAAP. Where there were once numerous requirements for recognizing revenue, there will be consistent principles regardless of industry and geography. This includes a single model that will be considered in relation to variables such as rebates, discounts, bonuses, or a right of return. These variables considerations will be included in transaction price to to ensure that a significant reversal in the cumulative revenue amounts recognized will not occur (Revenue Recognition, 2018).
With any new standard including the Accounting Standards Bulletin (ASC) Topic 606 Revenue from Contracts with Customers standard, auditors have to identify when management plans to implement the standard. ASC 606, effective January 1, 2018, is based on the principle that “an entity shall recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.” This new standard also established five new general criteria for recognizing revenue including identifying the contract with a customer, identifying the performance obligations in the contract, determine the transactions price, allocate the transaction price to the performance obligations in the contracts, and recognize revenue when the customer obtains control of the good or service. ASC 606 must be applied under one of two basic methods. The first method is fully retrospective and requires the restatement of revenues for all historical reporting periods covered in the financial statements. The second method is considered a modified retrospective with the reinstatement of prior period revenue (Dixon, Odoner & Alterbaum, 2017).
Some of the five step process is self-explanatory, but some it is going to be accompanied by discrepancies. Identifying a contract with a customer can refer to one that is written, oral, or agreed-upon in another manner. The completion of the performance obligation marks the recognition of revenue, but a contract can have more than one performance obligation. The total transaction price has to be allocated to the different obligations and will reflect “the amount of consideration to which an entity expects to be entitled in exchange for transferring goods or services” (“Revenue recognition issues”, 2018). The price may have to reflect time value of money, and it may include estimates of variable consideration. These goods and services might not transfer at a specific point in time; rather, they might transfer over time and there are other guidelines when this occurs.
This new standard will have a dramatic effect on the financial reporting world. Revenue is one of the largest financial statement accounts and drives operations, so this standard in particular will be an important focus for the auditors to ensure that the financial statements stay in accordance with GAAP, and the application of this standard is properly disclosed and explained to any potential users of financial statements. A major concern will be how this standard will result in “substantial differences. . . for contractual revenues and costs. . . in certain industries” because it will cause the financial statements to completely deviate from the current trend lines that were leading up to its adoption (Dixon, et al., 2017). However, the standard is required to be applied retrospectively so prior periods will have to be restated. There are a significant amount of industries that will be more significantly impacted, and this includes Automotive, Entertainment and Media, Technology, Engineering and Construction, Aerospace and Defense, and many more (“Revenue recognition issues”, 2018).
Many modern companies are facing changes with their contracts on a regular and recurring basis, and this will complicate matters as far as how that revenue will need to be reported (Reddy, 2018). Many companies will be recognizing revenue sooner than they would have prior to the standard, and with added questions and complications in reporting, they may decide to simplify their contracts so it is easier to account for variable pricing, bonuses, and non-cash items (Gest, 2018). Companies were given four years before they had to comply with these standards, and the ones that will be prepared for the new standard are the ones that started working on it years ago. Otherwise, it is going to be a tough objective to look over the company’s contracts and report revenue correctly. In most cases, an updated revenue recognition software will be required for correct compliance. As stated earlier, non-compliance is a major risk because these errors result in earnings misstatements, which can result in “firings, fines, and even jail time” (Reddy, 2018).
Another area that will be significantly affected by the new accounting standard is a company’s internal control. The team will have to assess and reassess the impact of the standard on their existing accounting methods and apply these principles in a timely and proper manner. They will also have to adjust their training methods and ensure their current and prospective staff members are current on these updates. Management, especially at the top of the organizational chart, must lead by example, set high expectations, and make sound judgments when supporting the new accounting standard. They will be the ones held accountable for the new standard’s successful adoption and the rest of the organization will not understand its importance until they see it being addressed by management. Technology has to be used to assist in preparing the books and records and re-designing processes of internal control. Proper documentation of the main points of this accounting standard along with anything that internal control finds important needs to be recorded and passed on so future discussions about discrepancies can be resolved more quickly with this transfer of knowledge.
With the addition of this new accounting standard, there are new roles required of the audit committee in order to best facilitate the transition to the new principle of revenue recognition. Audit committees must be well versed in the implementation plans of management as well as in their progress while making the required changes to the internal controls. They have been instructed to anticipate, and for the most part require, verbal communication with the outside auditor about their perspective on the progress of control implementation. Audit committees are adamant about encouraging management in their successful implementation of ASC 606. Like past standard application, committees set the tone for its adoption by monitoring and supporting management efforts. This includes regular meetings with management to discuss progress toward new standard implementation and the development of a project plan complete with working sessions to evaluate potential differences in customer arrangements that could result from putting the new standard into practice (Dixon, et al.,2017).
ASC 606 is a ground-breaking standard for the accounting world, and companies have many different changes to implement into their accounting process once they adopt ASC 606. The expanded disclosure requirements for the revenue recognition steps have required auditors to keep this in mind when performing their audits. They will have to put more emphasis on recognizing this new standard’s effect on the financial statements. With the standard affecting one of the largest financial statement accounts, auditors will have to know this standard better than anyone to ensure that the statements are properly presented and are not materially misstated. For