An Update on the Revenue Recognition and Lease Standards

The Latest on FASB’s New Revenue Recognition StandardWhat’s new in the world of accounting right now? Let’s take a look at two topics that continue to be in the news: the revenue recognition standard and the lease standard.

Revenue Recognition Standard

Since the May 2014 release of the new revenue recognition standard issued by the Financial Standards Board (FASB), there have been five amendments to Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), to clarify how the principles of the new revenue standard should be applied.

The first of these updates, ASU 2015-14, deferred the effective date of the standard by one year. The effective date for public, calendar year-end entities is January 1, 2018 and January 1, 2019 for nonpublic entities.

The revenue recognition standard affects public, private, and not-for-profit entities that have contracts with customers. It eliminates the transaction and industry-specific revenue recognition guidance that currently exists under GAAP and replaces it with a principle based approach aimed to eliminate complex rules, increase comparability, and enhance disclosures.

The core principle of the standard is that an entity should recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To apply this principle, the guidance outlines a five step approach:

Step 1- Identify the contract with the customer
Step 2- Identify the performance obligations
Step 3- Determine the transaction price
Step 4- Allocate the transaction price
Step 5- Recognize revenue when (or as) a performance obligation is satisfied

The other amendments address implementation concerns by clarifying the guidance, providing additional expedients, and making technical corrections. Those amendments include:

  • ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net)
  • ASU 2016-10, Identifying Performance Obligations and Licensing
  • ASU 2016-12, Narrow- Scope Improvements and Practical Expedients
  • ASU 2016-20, Technical Corrections and Improvements to Topic 606

Upon adoption, some entities may be required to accelerate or defer revenue recognition because of the differences in the requirements. How an entity chooses to adopt the standard dictates the years that revenue and the direct effects of the change in accounting principle associated with contracts will need to be restated.

Application methods include an option for full retrospective adoption whereby the entity would restate all prior periods. Entities electing retrospective application are permitted to use any combination of several practical expedients which are to be applied consistently to all contracts and require disclosure of use of those practical expedients.

Alternatively, an entity may elect to use a modified retrospective approach for transition to the revenue standard with the cumulative effect of initially applying the standard recognized as an opening balance sheet adjustment to equity in the period of initial application, supplemented by additional disclosures.

Lease Standards

Unlike the revenue recognition standard, the leasing ASU 2016-02, Leases (Topic 842), has not been modified since its long awaited release in February 2016. It is expected to impact almost all entities to some extent, with the most significant impact to the balance sheet of lessees.

The core principal is that a lessee should recognize the assets and liabilities that relate to leases on the balance sheet. Current GAAP requires only capital (finance) leases to be recognized on the balance sheet. Upon adoption of ASU 2016-02, operating leases in excess of 12 months will be required to be recognized on the balance sheet in the form of a right-of-use asset and lease liability in addition to financing leases. The amendments become effective for public, calendar year-end entities January 1, 2019 and January 1, 2020 for nonpublic entities.

In preparing to implement the new leasing standards, entities should be focused on gathering the required data on existing leases which will be critical for an effective transition. Companies will need to quantify the additional liabilities in their balance sheets after adopting the ASU in order to assess the impact to their entity’s financial metrics. Increased leverage may result in debt covenant violations and will require entities to critically analyze definitions within their debt agreements so they are able to discuss the ASU’s potential effects on debt covenants with their lenders.

Vanessa Rhoades can be reached at vrhoades@kmco.com or 215.441.4600.

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