The start of 2018 brings a new set of accounting pronouncements that will take effect. One of these pronouncements is Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 606, Revenue from Contracts with Customers, or as it sometimes referred, the new revenue recognition standard.
The new standard is effective for public companies for annual reporting periods beginning after December 15, 2017 (January 1 for those entities with a December 31 year-end). Private entities are required to adopt this standard in 2019. Regardless of whether you are a public company putting your last minute touches on implementation or any other entity still analyzing the potential changes, there are several practical implications to consider in addition to the technical requirements.
Processes and Controls
The new standard will require more judgment, compared to the historical rules that included much more transaction and industry-specific guidance. As a result, companies will want to consider implementing new policies for reviewing estimates. In addition, documentation of these estimates will be key, so implementing new processes and controls will aid in maintaining consistency in applying and documenting judgments.
Going hand-in-hand with processes and controls are IT systems. Companies should evaluate whether their current systems are capable of handling these changes under the new standard. If not, review controls will need to be put in place to ensure accuracy in the financial information.
The new standard also mandates significant disclosures not previously required. Although these disclosures are less burdensome for companies that are not public, all companies should evaluate their IT systems (i.e., general ledger packages) to determine whether they are set up to capture and report this newly-required information.
Contract Implications
Historically, some companies may have managed to the accounting rules and structured contract terms to address the objective standards. With the new standard being more principles-based, there may be an opportunity to do away with those contract terms. Better yet, companies might have an opportunity to bundle their products in new ways, which may counteract or offset some of the anticipated changes to the accounting resulting from the new standard.
Compensation, Debt, and Other Agreements
Companies likely have compensation, debt, and other agreements (i.e., contingent earn outs in a purchase and sale agreement) based on amounts recognized for generally accepted accounting principles (GAAP). If so, keep in mind that those amounts likely will be changing, which could create unintended calculation results. The consequences could include having either a financial statement impact, a cash outlay impact, or both.
Companies should pause before changing agreements because amending an agreement could have its own financial statement or other effects. Inventory and evaluate the agreements currently in place and consider all impacts, including the impact it might have on an employee’s perception and motivation.
As part of that, do not forget to factor in other significant projects on the FASB’s agenda, including the new lease standard, which will likely have a major effect on debt agreements and related covenant calculations.
Deferred Tax Implications
The new standard might bring about variations in the timing of revenue recognition for GAAP, among other changes. As a result, there may be differences in book versus tax revenues that could result in modifications to deferred tax assets or liabilities. Keep in mind that there may also be changes to existing deferred tax assets or liabilities upon adoption of the new standard. This is because the new standard requires either a full retrospective or a modified retrospective transition.
The new standard will have significant impacts to many areas, not just those above. Allow yourself and your company as much time as possible to evaluate and prepare for those changes.
Craig B. Evans can be reached at Email or 215.441.4600.