FASB Creates New Codification Topic on Revenue Recognition

The Financial Accounting Standards Board (FASB) is amending the FASB Accounting Standards Codification® and creating a new Topic 606, Revenue from Contracts with Customers, and the IASB is issuing IFRS 15, Revenue from Contracts with Customers.

The revenue recognition update establishes that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the amount an entity expects to receive exchange for those goods/services.

To accomplish this, there are five steps that an entity should apply:

Step 1: Identify the contract(s) with a customer.

Step 2: Identify the performance obligations in the contract.

Step 3: Determine the transaction price.

Step 4: Allocate the transaction price to the performance obligations in the contract.

Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation.

Step 1: Identify the Contract(s) with a Customer

The following should apply to the requirements to each contract that meets the following criteria:

  1. Approval and commitment of the parties
  2. Identification of the rights of the parties
  3. Identification of the payment terms
  4. The contract has commercial substance
  5. It is probable that the entity will collect the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer.

Step 2: Identify the Performance Obligations in the Contract

If an entity promises in a contract to transfer more than one good/service to the customer, the entity should account for each promised good/service as a performance obligation only if it is (1) distinct or (2) a series of distinct goods/services that are substantially the same and have the same pattern of transfer.

A good or service is distinct if both of the following are met:

  1. Capable of being distinct – The customer can benefit from the good/service
  2. Distinct within the context of the contract – The promise to transfer the good/service can be identified separately from other promises in the contract

Step 3: Determine the Transaction Price

To determine the transaction price, an entity should consider the effects of:

  1. Variable consideration
  2. Constraining estimates of variable consideration
  3. The existence of a significant financing component
  4. Noncash consideration
  5. Consideration payable to the customer

Step 4: Allocate the Transaction Price to the Performance Obligations in the Contract

For more than one performance obligation within a contract, an entity should allocate the transaction price to each performance obligation in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for satisfying each performance obligation. An entity should allocate to the performance obligations in the contract any subsequent changes in the transaction price on the same basis as at contract inception.

Step 5: Recognize Revenue When (or As) the Entity Satisfies a Performance Obligation

An entity should recognize revenue when (or as) it satisfies a performance obligation by transferring a promised good/service to a customer. The control of a good/service transfers over time, therefore, satisfies a performance obligation and recognizes revenue over time if one of the following is met:

  1. The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs.
  2. The entity’s performance creates or enhances an asset (ex: work in process) that the customer controls as the asset is created or enhanced.
  3. The entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date.

Industry Task Forces

To help develop the new Accounting Guide on Revenue Recognition, the American Institute of CPAs (AICPA) has formed sixteen industry task forces. These task forces will provide helpful hints and detailed examples of how to apply the new Revenue Recognition Standard. The sixteen industries are:

  • Aerospace and Defense
  • Airlines
  • Broker-Dealers
  • Construction Contractors
  • Depository Institutions
  • Gaming
  • Health Care
  • Hospitality
  • Insurance
  • Investment Companies
  • Non-profit
  • Oil and Gas
  • Power and Utility
  • Software
  • Telecommunications
  • Timeshare

When Will the Amendments Be Effective?

The following are the effective dates for the Revenue Recognition update:

  • For a public entity, the amendments are effective for annual reporting periods beginning after December 15, 2016. Early application is not permitted.
  • For all other entities (nonpublic), the amendments are effective for annual reporting periods beginning after December 15, 2017.

An entity should apply the amendments using one of the following methods:

  • Retrospectively to each prior reporting period presented.
  • Retrospectively with the cumulative effect of initially applying this update recognized at the date of the initial application.

If you have any additional questions about this new standard, please do not hesitate to contact one of the partners at Melton & Melton at 281-759-1120.