revenue

Private companies: Have you implemented the new revenue recognition standard?

Private companies that follow U.S. Generally Accepted Accounting Principles (GAAP) must comply with the landmark new revenue recognition standard in 2019. Many private company CFOs and controllers report that they still have significant work to do to meet the demands of the sweeping rules. If you haven’t started the implementation process, it’s time to get the ball rolling.

Lessons from public company peers

Affected private companies must start following Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Accounting Standards Codification Topic 606), the first time they issue financial statements in 2019. For private companies with a fiscal year end or issuing quarterly statements under U.S. GAAP, that could be within the next few months. Other private companies have until the end of the year or even early 2020. No matter what, it’s crunch time.

Public companies, which had to begin following the standard in 2018, reported that, even if the new accounting didn’t radically change the number they reported in the top line of their income statements, it changed the method by which they had to calculate it. They had to comb through contracts and offer paper trails to back up their estimates to auditors. Public companies largely reported that the standard was more work than they anticipated. Private companies can expect the same challenges.

An overview

The revenue recognition standard erases reams of industry-specific revenue guidance in U.S. GAAP and attempts to come up with the following five-step revenue recognition model for most businesses worldwide:

  1. Identify the contracts with a customer.
  2. Identify the performance obligations in the contract.
  3. Determine the transaction price.
  4. Allocate the transaction price to the performance obligations.
  5. Recognize revenue as the entity satisfies a performance obligation.

In many cases, the revenue a company reports under the new guidance won’t differ much from what it reported under old rules. But the timing of when a company can record revenues may be affected, particularly for long-term, multi-part arrangements. Companies also must assess:

  • The extent by which payments could vary due to such terms as bonuses, discounts, rebates and refunds,
  • The extent that collected payments from customers is “probable” and won’t result in a significant reversal in the future, and
  • The time value of money to determine the transaction price.

The result is a process that offers fewer bright-line rules and more judgment calls compared to old U.S. GAAP.

We can help

Our accounting experts can help you avoid a “fire drill” right before your implementation deadline and employ best practices learned from public companies that made the switch in 2018. Contact us for help getting your revenue reporting systems, processes and policies up to speed.

© 2019

Why revenue matters in an audit

For many companies, revenue is one of the largest financial statement accounts. It’s also highly susceptible to financial misstatement.

When it comes to revenue, auditors customarily watch for fictitious transactions and premature recognition ploys. Here’s a look at some examples of critical issues that auditors may target to prevent and detect improper revenue recognition tactics.

Contractual arrangements

Auditors aim to understand the company, its environment and its internal controls. This includes becoming familiar with key products and services and the contractual terms of the company’s sales transactions. With this knowledge, the auditor can identify key terms of standardized contracts and evaluate the effects of nonstandard terms. Such information helps the auditor determine the procedures necessary to test whether revenue was properly reported.

For example, in construction-type or production-type contracts, audit procedures may be designed to 1) test management’s estimated costs to complete projects, 2) test the progress of contracts, and 3) evaluate the reasonableness of the company’s application of the percentage-of-completion method of accounting.

Gross vs. net revenue

Auditors evaluate whether the company is the principal or agent in a given transaction. This information is needed to evaluate whether the company’s presentation of revenue on a gross basis (as a principal) vs. a net basis (as an agent) complies with applicable standards.

Revenue cutoffs

Revenue must be reported in the correct accounting period (generally the period in which it’s earned). Cutoff testing procedures should be designed to detect potential misstatements related to timing issues, as well as to obtain sufficient relevant and reliable evidence regarding whether revenue is recorded in the appropriate period.

If the risk of improper accounting cutoffs is related to overstatement or understatement of revenue, the procedures should encompass testing of revenue recorded in the period covered by the financial statements — and in the subsequent period.

A typical cutoff procedure might involve testing sales transactions by comparing sales data for a sufficient period before and after year end to sales invoices, shipping documentation or other evidence. Such comparisons help determine whether revenue recognition criteria were met and sales were recorded in the proper period.

Renewed attention

Starting in 2018 for public companies and 2019 for other entities, revenue must be reported using the new principles-based guidance found in Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. The updated guidance doesn’t affect the amount of revenue companies report over the life of a contract. Rather, it affects the timing of revenue recognition.

In light of the new revenue recognition standard, companies should expect revenue to receive renewed attention in the coming audit season. Contact us to help implement the new revenue recognition rules or to discuss how the changes will affect audit fieldwork.

© 2018