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Revenue Recognition and Lease Accounting Standards Insights

They are both hefty in size and complexity: The arrival of ASC 606, “Revenue from Contracts with Customers,” ASC 842, “Leases,” was a long time coming, and their complexity was exacerbated by the fact that their initial implementation deadlines were practically back to back. Fortunately, for the privately held companies that have yet to implement the lease accounting standards and revenue recognition standards, or are in the process of implementing them, they can lean on early adopters’ experiences.

Both the lease accounting and the revenue recognition standards have been open to interpretation for awhile now. However, your finance team is likely to run into challenges as they consider how the guidance applies to your company’s unique situation and circumstances.

Changes to Revenue Recognition Accounting: ASC 606

First, the basics: What is the revenue recognition accounting standard? At over 700 pages, ASC 606 shook up how companies recognized revenue—previous guidance was different for different industries and involved lots of bright lines. With one standard to follow now for revenue recognition accounting and more principles-based guidance, companies are directed to focus on a core concept: Recognition of revenue for goods and services happens when control is passed on to the customer.

The standard calls on companies to follow a five-step process when recognizing revenue: (1) identify the contract; (2) identify the separate performance obligations; (3) determine the transaction price; (4) allocation the transaction price to separate performance obligations; and (5) recognize revenue when each separate performance obligation is delivered.

The changes to the revenue recognition accounting resulted in some companies re-evaluating their revenue recognition policy and making changes to the structure of their contracts and related processes.

Implementation Challenges of the Revenue Recognition Standards

For companies new to ASC 606 as they bring their company in line with GAAP, revenue accounting has always been one of most scrutinized areas and needs to be done with great care.

As your company works through it, you’ll need to gather a lot of data around the company around the timing and scope of goods and services that are promised to customers. Practical methodologies will need to be developed for making variable consideration estimates. And disclosures and processes around disclosures will need to be created. Many disclosures will center on a key difference between this standard and old revenue recognition standards—because there is more judgment allowed, you’ll need to be forthcoming about how you arrived at your judgement calls when looking at revenue. For instance, you’ll need to disclose any significant adjustments involved in identifying performance obligations.

Changes to Lease Accounting: ASC 842

What is the lease accounting standard? Private companies have until January 2022 to implement ASC 842, which calls on companies to bring their right-of-use assets and associated obligations onto the balance sheet, and out of the footnotes. Companies that have already gone through this process quickly saw their balance sheet get weighed down, as putting operating leases on their balance sheet make them appear more leveraged than under historical GAAP. The idea behind ASC 842 was to give a clearer view of companies’ leasing activities, and it has made companies evaluate their finance lease accounting, capital lease accounting and operating lease accounting as a result.

Implementation Challenges of the Lease Accounting Standards

Taking on the lease accounting standard can be incredibly challenging for companies that have not centralized their leasing processes. If different parts of your company have made agreements along the way, as your company grew, you could be in for some surprises for the type and number of deals your company has made that fall under this guidance.

Like the revenue recognition standard, once you start getting a handle on your company’s many leases, you may want to revisit how leasing contracts are structured and build processes around that. To ease the workload and to make sure the company is making the right decisions for the long term, lease accounting experts can be a great help here. They can lead the implementation effort while checking in with the various organizations at your company to make sure every leasing issue is covered. Every step of the way, they will make sure decisions will hold up to auditor scrutiny.

Benefit from Earlier Adopters of ASC 606 and ASC 842

Taking on these accounting standards can be overwhelming, but you have an advantage over the companies that have finished up their implementations. You can lean on the wisdom of finance and accounting pros who know these accounting standards inside and out, and are armed with best practices to make sure your implementations will be seamless and that your team knows what to do going forward.

Learn more about how our technical accounting experts help companies with their accounting standard implementations, and let us know about your most pressing accounting issue, so that we can get you through it.

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Beyond rev rec—planning ahead for 2018 financial reporting

I get it—implementing the new revenue recognition rules has consumed a lot of your technical accounting team’s time, as it has at my company. The new standard likely has a steady spot at the forefront of your audit committee’s accounting concerns as well. It’s a big deal, but other new rules issued by the Financial Accounting Standards Board last year deserve attention, too. They must be implemented in fiscal 2018 if you’re a public company in addition to rev rec.

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Planning ahead and maybe even early adopting these new accounting rules could make your life easier a year from now. Presumably (I hope!) you are well on your way in implementing the new rev rec rules, so now may be an ideal time to consider adoption strategies for the other new rules on your plate.

If that concept sounds daunting, take solace in this: You can pick up on the “lessons learned” from your rev rec implementation and apply it to these other implementations, including identifying what new data (and data sources) are required, as well as ensuring you have appropriate internal controls over adoption of new standards. For example, all adoptions require companies to determine if the effect at the adoption date will be material. This requires the computation of the effect to be accurate as well as a process to make sure you have identified the complete population of affected transactions.

Ready to dive in? Here is the next round of accounting changes you need to consider.

1. Changes ahead to cash-flow statements

Let’s start off with ASU 2016-18, which deals with how companies present restricted cash and restricted cash equivalents in the statement of cash flows. It’s not a difficult change to apply, it improves the user’s understanding of a company’s cash position, and it can be early adopted. So, if you have either restricted cash or restricted cash equivalents this year or in previous years, why not adopt now?

The standard can be adopted in any interim quarter. Keep in mind it must be applied retrospectively—whether you do it now or in Q1 2018, you are going to have to restate your statements of cash flows for prior years.

While you’re at it, ASU 2016-15, which also deals with reporting in the statement of cash flows, allows early adoption with the same retrospective transition rules. It makes sense to adopt both ASUs at the same time as users would likely prefer to see all changes reflected at once.

ASU 2016-15 is worth a review to see if any of the eight cash transactions it specifically calls out apply to you. The transaction types are not all infrequent among the companies I work with—two, for example: amounts paid to extinguish debt, including prepayments and payments for contingent consideration in a business combination. If you’ve got those, you may have some changes ahead of you.

And early adoption is not just an idea for public companies; it might also make sense for private companies as they will have to adopt no later than 2019. If you’ve got an IPO in the future, adopting now is one less change you’d have to make before taking on public-company GAAP.

2. Got a deal coming up? Is it a “business” or an “asset”?

ASU 2017-01 defines a business as opposed to an asset in transactions involving acquisitions, transfers, or disposals of a set of assets and activities. It’s another of the FASB’s projects for making transactional analysis more efficient by narrowing the definition when applying the rules for business combinations.

This one is also required to be adopted in 2018—prospectively—so it will apply to transactions on or after the adoption date. But if you expect to have a transaction sometime during the rest of 2017, definitely take a look at whether this new standard will affect your accounting in a way that makes more sense for your company’s situation.

Pundits are predicting that more acquisitions will be accounted for as acquisitions of assets, rather than business combinations. The differences in accounting are significant—for example, transactions accounted for as asset acquisitions will not have goodwill recorded but will require you to capitalize transaction costs.

While this is the first in the FASB’s project to define and clarify what a “business” is, keep in mind that the definition of a business also comes into play for identifying reporting units for goodwill impairment tests and consolidation.

3. Impairments and intangibles

Segueing into the subject of impairment, simplified rules for impairment analyses of intangibles, including goodwill, in ASU 2017-04 are also available for early adoption this year, prospectively, for any impairment measurements performed in 2017 for financial statements not yet issued.

The new rule removes the requirement to perform a hypothetical purchase price allocation, which involves determining the fair value of the individual assets and liabilities. Now, you can do a much simpler measurement by comparing the fair value of the reporting entity as a whole to its carrying value.

4. An accounting change for some equity investments

To fill out the rest of your technical accounting implementation work plan for Q1 2018, ASU 2016-01 affects accounting for equity investments classified as available for sale, which is not an uncommon investment.

It requires companies to record all changes in fair value, including impairments, in the income statement—not in other comprehensive income as we do today. This is going to mean more variability in earnings, so investors will need to be educated about why they’ll see changes.

Know that this is the one ASU on this list that cannot be early adopted. The standard has other provisions you should take a look at, too.

 

Do the work now, thank yourself later

With all these changes, keep in mind you may have more than just rev rec and the new accounting rules for leases affecting your ongoing SAB 74 disclosures, as well as planning for disclosures required under ASC 250 when adopting any new accounting standard.

My best advice? Plan ahead, and do what you can to be in front of the work. Keep your team and audit committee informed of what to expect. This way you’ll avoid surprises and an overwhelming workload for first quarter 2018.

Get the scoop on the accounting changes in store with the RoseRyan Technical Accounting Group’s fast-paced 90-minute webinar session, “Our Take from the Trenches on the Latest FASB Updates and What You Need to Know.” Go to bit.ly/FASBupdates to register for this webinar taking place Thursday, June 15, 10am-11:30am PT. 

Julie Gilson is a senior consultant with RoseRyan and a CPA (inactive) with over 15 years working in finance and accounting with fast-moving public and private technology companies. 

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How to amp up your year-end disclosures for the revenue accounting changes ahead

It’s always healthy to take a fresh look at your disclosures and discussions in your annual reports. Situations change, boilerplate language doesn’t always cut it, and changes in accounting policies make it a necessity. This year, more than ever, several drivers make such a review a can’t-miss effort.

A number of new accounting standards are coming down the pike that will significantly change the information you provide. And investors and analysts want to understand now how these accounting changes will impact your financial statements and how you’ll report what is happening in your business.

So, we’re highlighting a few areas to focus on this reporting season, and we’re giving you a head-start on what you may want your related disclosures to say.

The new revenue standard

Arguably, this is the biggest change in accounting we will see in our lifetime—a generational change. Anticipating the shifts companies will be making in how they recognize revenue in the years ahead, the Securities and Exchange Commission has high expectations for your next round of disclosures. They’ll be looking out for the effects the new standard will have on your accounting through what’s commonly known as SAB 74 disclosures.

The SEC said from the start that they expect these disclosures to evolve as implementations progress. The SEC Corp Fin staff is now saying that they are done waiting, and it is no longer acceptable to limit your disclosures to boilerplate “we are still evaluating” language in your calendar Q1 2017 filings (10-Ks, 10-Qs). They upped their scrutiny in this area with Q3 filings and expect to see more robust disclosures for year-end.

Companies that don’t meet these expectations will likely receive a comment letter asking for more information. The SEC enforcement staff has even gone so far to say that they will pursue enforcement actions if SAB 74 disclosures are not robust enough.

So, what should you be saying?

In your footnote disclosures, you should assess the expected impact of the new revenue standard or, at a minimum, provide directional guidance in the areas that are relevant to your business. See below for some examples:

  • The timing of revenue recognition.“The Company expects revenue recognized on a cash basis today to be recognized earlier under the new standard.”
  • How revenue allocations among multiple deliverables will change.“The Company expects the revenue allocation between software licenses, maintenance, and other services to change, since the estimated consideration will be allocated between each performance obligation based on relative selling prices rather than using a residual method for software licenses under the current guidance.”
  • The impact of variable consideration estimates, such as contingent payments, customer discounts, and price protection rebates.“The Company expects to include sales-based milestone payments that are probable of payment in our estimates of variable consideration, resulting in more revenue recognized as associated performance obligations are delivered rather than waiting for the milestone payment to be paid.”
  • The impact of shifting from a sell-through to sell-in revenue recognition model when estimating returns.
  • Changes in the timing of revenue recognition from separating financing components from contract consideration.“The Company expects contracts with extended payment terms to be recognized earlier after separating a financing component from the consideration.”
  • The capitalization of costs that are incremental to each contract and recognition concurrent with the associated revenue.
  • Quantification of the overall impact of the standard.

Have you done your diligence with the new standard and believe it won’t make much of a difference? If you expect the impact of adoption to be immaterial to your financial statements, you still need to address it and explain your reasoning. Here’s an example of language you could use:

  • “The Company expects the impact of adoption to be insignificant to its financial statements, since its contracts are simple with only one performance obligation delivered at a point in time for a fixed price. The only new accounting element will be the capitalization of costs incremental to each contract and recognition concurrent with revenue, which is accrued when the order is placed and recognized when the goods are delivered.”

You should also include facts about your implementation of the new standard:

  • When you expect to adopt and your planned transition method.“The Company intends to adopt the new revenue standard as of January 1, 2018, with a modified retrospective transition approach.”
  • The status of your implementation.“The Company has completed our evaluation of the changes in accounting for representative transactions under the new guidance.”
  • Significant areas you still need to address and when you expect to address them. “The next areas to address in the implementation are: (i) establishing relative selling prices for each performance obligation, (ii) assessing the accounting impact to the financial statements, (iii) developing tools to monitor the additional information needed, (iv) preparing the accounting entries for adoption, and (v) writing supplemental footnote disclosures. The Company expects to complete these efforts by the fourth quarter of 2017.”

In your MD&A discussions about the new revenue standard, you should emphasize the future impact of the new accounting treatment:

  • Material changes and trends: Under the new standard, for instance, do you expect more variability because revenue will be recognized earlier, or will you have to make significant estimates?
  • Financial and non-financial impacts: For example, changes in the balance sheet for contract assets and liabilities may affect key financial ratios that are embedded in debt covenant requirements.
  • Significant estimates and judgments: Consider estimates related to variable consideration and the constraint on variable consideration, including returns, price protection rebates, and cash discounts or the probability of milestone payments. Another example is the estimation of standalone selling prices and the allocation of discounts and variable consideration in allocating the transaction price.

Other areas to refresh

While the new revenue standard may be the most significant change that you need to address in your financials this year, a few other areas also warrant your attention.

Management’s assessment of going concern

You are now required to perform your own assessment as to whether there is substantial doubt about your company’s ability to continue as a going concern within one year after the date you’ll be issuing your financial statements (so if you file your 10-K in March 2017, you would need to assess your ability to continue as a going concern through March 2018).

If conditions or events raise substantial doubt about your ability to meet your obligations, you need to consider management’s plans to mitigate those doubts if (1) it is probable you can implement those plans and (2) those plans will mitigate the doubt.

Substantial doubt about the company’s ability to continue as a going concern will require expanded footnote disclosures that cover the period through 12 months from the date of financial statement issuance (instead of prior disclosures that focused on 12 months from the balance sheet date).

SAB 74 disclosures for other new standards

Don’t forget, you also have SAB 74 disclosure requirements for other new accounting standards, including:

  • Leases, which is scheduled for adoption in 2019 for public companies and 2020 for private companies. Example language beyond standard boilerplate might include:“The Company’s leases are limited to operating leases for the Company’s corporate headquarters and regional sales offices. Management is currently evaluating the impact of adoption. While management cannot yet estimate the amounts by which its financial statements will be affected, the Company has identified the following changes. The Company expects the recognition of expense to be similar to current guidance under the new standard. And there will be a significant change in the balance sheet due to the recognition of Right of Use Assets and corresponding Lease Liability. The Company plans to adopt the new Leases standard effective January 1, 2019, following a modified retrospective transition method.”An item to consider highlighting in your MD&A discussions would be any expected impact on debt covenant financial ratios caused by leases coming onto the balance sheet.

During this refresh process, keep at the top of your mind the changes that have caught your attention or caused you concern. Provide enough information to investors and analysts to help them understand the significant impacts of new standards on your business.

No one likes to be at the bleeding edge by expanding disclosures before they have to, but don’t be left behind. Expect that across the board, companies will be sharing expanded disclosures about new accounting standards this 10-K filing season—particularly related to the new revenue standard.

You will be the odd man out if you don’t make your own disclosures more robust.

The exact language you use for your disclosures depends on your facts and circumstances, of course. Feel free to contact us if you have any questions about the accounting changes ahead and how to deal with them.

Diana Gilbert, who heads our Technical Accounting Group, has been a member of the RoseRyan dream team since 2008 and has 30 years of professional experience. Frequently tapped for her insights by Compliance Week, Diana excels at technical accounting, revenue recognition, SOX/internal controls, business systems and process improvements.

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Conquer complexity: Get briefed on the latest accounting updates

In the accounting world, the rules are ever changing. Large in scope and long awaited, the new rule for recognizing revenue continues to get clarifications in the months leading up to its effective date. The new leasing standard is finally here as well and sharing the attention. Those are just the biggies—the Financial Accounting Standards Board has been coming out with a flurry of changes in recent months, and regulators are paying attention to what you are doing with them. There’s a ton of information to follow to stay compliant.

How equipped finance teams are to keep up with all the moving parts varies quite a bit. They oftentimes find it beneficial to lean on technical accounting experts who can decipher the never-ending landscape and help with interpretations. Such experts can help them stay on track in understanding the latest accounting refinements, transition-method choices and effective dates. Diana Gilbert, senior consultant at RoseRyan and head of our Technical Accounting Group, helped many companies get up to speed during the June 2 webinar, “Demystifying the Latest Major Accounting Changes.”

This fast moving, 90-minute, all-out binge covered the latest twists and turns that have come out from FASB and regulators over the past year. Some changes have simplified things. Others will have a narrow effect. And many will force finance teams to do some soul searching as the deadlines near. Contracts and compensation plans may need to be revisited.

Diana filled in listeners (most of whom were from life sciences and technology companies) on the five topics below, along with other changes, and gave timely advice along the way.

Revenue recognition: Companies that don’t have a game plan for the new revenue recognition standard are running out of excuses. The SEC has been “aggressively” referencing the new rule in recent speeches to let companies know they will be watching what gets said in disclosures, Diana said. Boilerplate, vague language won’t cut it much longer.

“This has been out there since 2014, so they are going to question why you’re still evaluating it now,” she said. “If you’re honestly, sincerely evaluating it, then just be prepared for the questions. But if you’ve done your evaluation and pretty much do understand the impact, then think about including more detailed disclosures, particularly about decisions you’ve already made,” such as the transition method the company will be taking and the planned adoption date.

Leases: The new standard finalized in February will bring what we refer to as operating leases today onto the balance sheet. The rule applies to leases of property and equipment with terms of at least one year and centers around the lessee’s “right of use” of an item (the obligation to pay for that right is what will appear on the liability side of the balance sheet).

The new rule could change behavior, Diana predicted. “Think about it. If you’re going to have it on the balance sheet anyway, are you still going to lease it or would you buy it outright?” she said. “You might create new forms of leases that are clearly less than a year, without the option to renew, and you’ll have to deal with the issue every year. That may make sense for inconsequential arrangements. It will be interesting to see what happens going forward.”

Financial instruments: Public companies will begin following new rules on classifying and measuring financial instruments for filings submitted in 2018, and private companies will do so a year later. Equity investments that are not consolidated are generally going to be measured at fair value through earnings. In some ways, disclosure requirements have been simplified with the rule changes—companies won’t have to disclose their methods and significant assumptions for estimating fair value—and in other ways they have expanded.

Stock-based compensation: Companies have “a grocery bag of different changes” to deal with when it comes to improvements to employee share-based payment accounting, Diana warned. The most significant relates to deferred tax assets. When the changes take effect, companies will no longer record excess tax benefits and certain tax deficiencies resulting from share-based awards in additional paid-in capital (APIC). APIC pools are eliminated under the changes.

Diana said this is a “huge simplification” in terms of tracking share-based compensation, but the downside is the potential for more volatility in the income statement. This particular change is applied prospectively from the date of adoption (which begins after December 15, 2016, for public companies).

SEC comments: The SEC staff has always tended to question areas that involve judgment and subjectivity, Diana noted. In recent years, in particular, they have been scrutinizing the statement of cash flows and whether companies’ internal controls are effective. Diana recommended that companies be as clear as possible and use tables and charts to help tell their story.

“Comment letters come about because they don’t understand what’s happening,” Diana said. “Or it’s a complex area and they’re going to ask you questions whether you like it or not.”

Keeping tabs on regulators’ areas of emphasis and accounting standard-setters’ changes takes time and effort. Things are in constant motion, and companies need to stay on top of it all. That’s how they can help minimize the questions that come from regulators and any uncertainty that may arise during implementation. To save time and effort in understanding the latest accounting standards (changes through June 1, 2016), feel free to check out the 90-minute replay of “Demystifying the Latest Major Accounting Changes” here.

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Get ready: FASB is dumping some big items on your to-do list

The Financial Accounting Standards Board has a bunch of resolutions that affect many companies. The board is offloading some of their weightier projects that have taken up a lot of time (several years!) on their docket.

Fortunately, they are giving financial statement preparers a lot of time to come to terms with the changes ahead, providing a couple of years to implement new standards for lease accounting and the classification and measurement of financial instruments.

The most highly anticipated one—the new leasing standard—will result in some companies looking more leveraged on their balance sheets, starting with their 2019 financial reports (privately held companies get an extra year). Companies that lease any property and equipment for one year or more will be impacted. This will be a really big deal.

In the works for a decade (the SEC called for a revamped standard in 2005), the new leasing rule created a rift during the ongoing convergence effort between FASB and the International Accounting Standards Board, leading the two boards to come out with two different standards. Call it a divergence if you will.

The IASB recently released their final standards and the FASB’s is expected this quarter. Companies will appear to be burdened by more debt than they do now, as disclosing leases only in footnotes will no longer be acceptable under GAAP. Studies estimate that the changes will raise the reported liabilities of U.S. public companies by $1.5 trillion to $2 trillion.

It is expected that the new rule will take more effort to put in place than the new revenue recognition standard (and that’s saying something). Consider that every lease must be reviewed with assumptions updated each reporting period. Under the new guidance, lessees will be required to present right-of-use assets and lease liabilities on the balance sheet.

FASB has passed down a couple of other big agenda items when it released its rules concerning financial instruments last month. Although not in the works as long as the pending changes to lease accounting, this project was also divisive for FASB and IASB. For FASB’s part, the board will require companies to follow new rules on classifying and measuring financial instruments in 2018 and financial instrument impairment in 2019.

FASB’s standard for how to classify and measure financial instruments will be relevant to most companies, in particular those that have equity method investments that are not currently measured at fair value. Current fair value measurements and disclosures can be confusing to investors, and the new rules are intended to simplify things. Companies can adopt parts of the standard early if they wish.

As for the new revenue recognition standard, the Joint Transition Resource Group had its last scheduled meeting in Q4 2015 and will reconvene if new issues arise around implementation of the new rule. The FASB is expected to finalize proposed amendments to the standard this quarter. So the rules are settling, and there is no more reason to delay your implementation efforts. You are already in the first fiscal year that will be effected by the new standard when you implement in 2018.

FASB’s agenda will appear a bit thinner by the second quarter of 2016, while yours has grown. Let the fun of implementation begin!

Diana Gilbert has been a member of the RoseRyan dream team since 2008 with almost 30 years of professional experience. Frequently tapped for her insights by Compliance Week, Diana excels at technical accounting, revenue recognition, SOX/internal controls, business systems and process improvements.

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How the new revenue recognition standard may affect your company

We’ve been hearing about it for years. Finally, the result of the joint project between the FASB and the IASB to update and consolidate accounting standards for revenue recognition into one global standard is just about here. They’re expected to issue it by the end of this month.

This is when the fun begins. While there is time before companies have to issue financial statements under the new standard (which we’ll see in the first interim period of 2017 for public companies with fiscal years beginning after December 15, 2016), they will need to disclose the expected impact of the new standard right away. And they will need to be tracking transactions under the new principles beginning in 2015.

The biggest change is the shift from industry-specific guidance to the application of general principles across all industries. Companies will need to re-think how revenue will be recognized for their transactions, and in some cases they will be able to record revenue earlier than they do now. Here are my thoughts on what our clients should be considering in the months ahead.

If you work at a life sciences company
The revenue standard applies to all contracts with customers, including some collaboration arrangements for life sciences companies if they are in effect transactions with a customer. Collaborations might fall outside the scope of the new revenue guidance if the collaborator or partner is not in substance a customer, such as when a biotechnology company and pharmaceutical company have an agreement to share equally in the development of a specific drug candidate as well as the risk that comes with it.

Another change that will arise with the new standard is that variable consideration (such as milestone payments) may be included in the transaction price allocated to deliverables as long as the company has relevant experience with similar performance obligations and, based on that experience, they do not expect a significant reversal in future periods. Changes to these estimates will have to be allocated to performance obligations based on that initial allocation, unless a payment relates to a specific element and is consistent with the amount expected to be entitled for performance of that obligation.

When life sciences companies license their drugs to commercialization partners, they can estimate and recognize sales-based royalties when the partners’ subsequent sales occur and will not have to wait, as they do now, until each partner has reported such sales. These estimates can include only the amount that has a low probable risk of significant reversal.

Another change that will result in earlier recognition of revenue for life sciences companies is the recording of sales of new products when they ship, minus the estimates for returns. Currently, companies have to delay recognition on a sell-through basis if a pattern of return has not been established.

If you enter into license agreements
The new standard’s emphasis on when control transfers to the customer may change the timing of revenue recognition on licenses. A license is the right to use an entity’s intellectual property, such as software and technology, patents, trademarks, copyrights, music and movie rights and franchises. In some cases, a license is a promise to provide a right, which transfers at a point in time. In other cases, it is a promise to provide access to a right that transfers to the customer over time, such as if a licensor has continuing obligations under the arrangement that do not otherwise qualify as separate performance obligations, or if the licensor must actively make the IP available on a continuous basis during the license period, or if the licensee benefits from changes over time.

If you have software arrangements
For software arrangements, VSOE (vendor-specific objective evidence) guidance is no longer required, resulting in earlier recognition of revenue for licenses that lacked it for undelivered elements, including future upgrades, additional product rights or other vendor obligations. Companies still need to allocate revenue to each of the deliverables in the arrangement based upon best estimated selling prices (BESP). It simply allows for alternate methods of determining BESP beyond VSOE.

If you sell software as a service
You will need to assess software license and hosting services to determine if they represent distinct performance obligations. It is unclear what criteria will apply to determine whether a typical SaaS arrangement will qualify for service accounting treatment (over time) or if the software element should be recognized separately (at a point in time).

In addition, provisions entitling the customer to a refund if undelivered elements are not successfully provided — an issue that currently delays recognition — will be a part of the estimate of variable consideration, resulting in earlier revenue recognition in some arrangements.

If you’re a contract manufacturer
In contract manufacturing situations, the timing of revenue recognition will no longer revolve around when units are delivered but instead when a service is performed and when the control of goods are transferred to the customer over time. This change may require contract manufacturers to modify their systems and processes to recognize revenue in the new way.

If you work in the technology sector
Distributors and resellers tend to require price protection or right of return from manufacturers of technology products to protect themselves from obsolescence and price reductions. Manufacturers currently delay recognition of revenue from these transactions because of the possibility they’d have to give money back or accept product returns. Under the new standards, fees that are currently not considered fixed and determinable can be recognized to the extent the company can estimate the amount that has a low probable risk of significant reversal. This will result in earlier recognition of revenue for manufacturers.

When companies license their technology for use in tangible goods or services, they can recognize the royalties when sales or usage occurs to the extent they can estimate the amount that won’t reverse (subject to the constraint on variable consideration). Today, recognition is typically delayed until such sales are reported by the licensee.

What everyone should do in the meantime
These are just a few examples of impacts in certain industries. When the new standard is released, we encourage you to evaluate its impact on your company and business model. Don’t underestimate the subtleties the new principles guidance will change in revenue recognition. Without bright-line rules, there will be room for judgment but also room for differences in interpretation and implementation, particularly between you and your auditor. Let the fun begin!

Diana Gilbert has been a member of the RoseRyan dream team since 2008 with almost 30 years of professional experience. She excels at technical accounting, revenue recognition, SOX/internal controls, business systems and process improvements.

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How to rise to the rev rec challenge

Accounting for revenue is no piece of cake, and it’s especially true for a lot of Silicon Valley firms. If your rev rec won’t stand up in an audit, you’ve got your work cut out for you.

RoseRyan guru Miranda Chook has seen her share of rev rec fiascos. “Firms with complicated multiple-element agreements can really get tripped up,” she says. “They don’t have or haven’t consistently applied the proper accounting treatment for their various revenue streams. After awhile, they’re really in the weeds. They’ve closed a lot of deals, but they’ve documented them in incorrect ways. Now the audit needs to happen. Panic!

“What companies need is an auditor-approved treatment that covers all revenue types. Then they need to go back and apply industry-specific GAAP literature to deals. Once the accounts are clean, they need a template going forward so they don’t get in the weeds again.”

If rev rec is the bane of your existence (or just a nagging worry), rest easy—it’s one of the things we live for. Find out how we helped one high tech firm rectify its revenue accounting and come through an audit with clean books and a user-friendly rev rec template.

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