How Companies Implemented the New Revenue Recognition Standard
Five years after the Financial Accounting Standards Board (FASB) first issued new revenue recognition rules, we finally get to see its impact on reported financials. The new standard was originally scheduled to go into effect in 2016, but the FASB delayed implementation until 2018 due to concerns over the difficulty of implementation. As a result, the first 10-K’s utilizing the new standard came out earlier this year for most companies.
While the new standard, ASU 2014-09 (also referred to as ASC 606), primarily deals with revenue, it will also have significant impacts on how companies report expenses, as well as assets and liabilities on the balance sheet.
Most companies have seen relatively little impact from the new revenue recognition rules, but for a handful of industries it significantly distorted revenue and earnings over the past year. This report digs into how the new rule works, what’s changed, and how investors should respond.
How the New Rule Works
The FASB announced the new revenue recognition rule in 2014 as part of an effort to standardize accounting treatments and continue to converge U.S. Generally Accepted Accounting Principles (GAAP) with International Financial Reporting Standards (IFRS). As the FASB wrote in the announcement of the new rule:
“Previous revenue recognition guidance in U.S. GAAP comprised broad revenue recognition concepts together with numerous revenue requirements for particular industries or transactions, which sometimes resulted in different accounting for economically similar transactions.”
The new revenue recognition standard replaced the more than 100 different industry and transaction-specific guidelines with a basic, five-step framework. Under the new rule, companies must carry out the following steps:
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.
In principle, these steps sound straightforward, but executing them is not always simple. The full standard runs 700 pages long with all the amendments included. These amendments give guidance on specific issues related to revenue recognition and outline the increased disclosure that will be required from companies under the new rules.
In addition to changing the way companies recognize revenue, the new rule impacts some of the expenses related to how companies obtain and satisfy contracts with customers. For example, companies now have more discretion to capitalize sales commissions for long-term contracts. Rather than being expensed immediately, these commissions are now recognized as contract assets on the balance sheet and amortized over the life of the contract.
All in all, the new standard was so complex that the FASB pushed back the implementation date to give companies more time to adjust. Fiscal year 2018 was the first year for which companies delivered fully audited financial statements under ASU 2014-09.
While every company that files under GAAP is subject to the new rule, the impact can vary widely. Some companies, like US Steel (X), saw no change to their financial statements. Others experienced significant boosts to revenue or earnings based on the new accounting rules. Below, we’ll walk through examples from three different industries that have been especially impacted.