The New Revenue Recognition Model – Topic 606, Revenue Contracts with Customers

Written on December 12, 2017

Introduction

In 2014, the FASB issued its landmark standard, Revenue from Contracts with Customers. It is generally converged with equivalent new IFRS guidance and sets out a single and comprehensive framework for revenue recognition. It takes effect in 2018 for public companies and in 2019 for all other companies, and addresses virtually all industries in U.S. GAAP, including those that previously followed industry-specific guidance such as the real estate, construction and software industries. For many entities, the timing and pattern of revenue recognition will change. In some areas, the changes will be very significant and
will require careful planning.

The new standard also introduces an overall disclosure objective together with significantly enhanced disclosure requirements for revenue recognition. In practice, even if the timing and pattern of revenue recognition do not change, it is possible that new and/or modified processes will be needed in order to comply with the expanded disclosure requirements.

Background

The FASB’s joint project with the IASB to develop a new accounting standard for revenue recognition dates back over a decade. The U.S. and international standard setters had noted inconsistencies and weaknesses in each of their respective accounting standards. In IFRS, there was significant diversity in practice because existing standards contained limited guidance for a range of significant topics, such as accounting for contracts with multiple elements; should these be accounted for as one overall obligation, or as a series of separate (albeit related) obligations? Under U.S. GAAP, concepts for revenue recognition had been supplemented with a broad range of industry-specific guidance, which had resulted in economically similar transactions being accounted for differently.

Both the FASB and the IASB also noted that existing disclosure requirements were inadequate, as they often resulted in insufficient information for users of financial statements to understand the sources of revenue, and the key judgments and estimates that had been made in its recognition. The information disclosed was also often ‘boilerplate’ and uninformative.

The new standard establishes a single, comprehensive framework which sets out how much revenue is to be recognized, and when. The core principle is that a vendor should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the vendor expects to be entitled in exchange for those goods or services.

Revenue will now be recognized by a vendor when control over the goods or services is transferred to the customer. The application of the core principle is carried out in five steps.

Step 1 – Identify the Contract

Step 2 – Identify Separate Performance Obligations

Step 3 – Determine Transaction Price

Step 4 – Allocate Transaction Price to Each Performance Obligation

Step 5 – Recognize Revenue When/As Performance Obligations are Satisfied

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