Contracts Present a Challenge When Adopting the New Revenue Recognition Standard
Revenue recognition is a complex accounting area that companies cannot afford to get wrong. The new revenue recognition standard, ASU 2014-09, Revenue from Contracts with Customers (Topic 606) goes into effect on December 15, 2017, for public entities and other entities one year later. The countdown is on, and it’s causing a lot of apprehension over the work involved in making the transition.
Earlier this year, Accounting Today released the results of a survey of accounting and finance executives on the implementation issues they find most difficult. The number one issue cited by respondents was Contract Reviews (78%). Here’s a look at the requirements and how companies can address them.
What is a Contract?
Step one of applying the new standard involves identifying the contract. FASB (Financial Accounting Standards Board) says an entity should apply the requirements to each contract that meets the following criteria:
- Approval and commitment of the parties
- Identification of the rights of the parties
- Identification of the payment terms
- The contract has commercial substance
- 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.
Contracts Don’t Need to be Written
We typically think of a contract as a written legal document, but under the new standard, contracts can be written, oral, or implied by customary business practices. If you legitimately don’t have a contract, then you cannot recognize revenue until you receive cash.
Contracts Differ from Business Practices
Perhaps you have a contract with a customer, but your business practices differ from what is on the contract. For instance, your contract states that a customer has 90 days to return goods, but in practice, you allow returns for 12 months. If you have a contract but aren’t following contract terms, that could signify that your compliance function has not been evaluated or approved. Now is the time to make sure that your business practices and contracts are in alignment.
Contracts Aren’t Standardized
The survey found that many companies are surprised by the number of non-standard contracts they have with customers. Non-standard contracts require more effort during the review process, and your auditors will likely need to test a greater number of contracts for audit purposes.
If your contracts are not standardized, it’s time to work toward that. Standardized contracts lead to greater consistency in accounting treatment, a smaller volume of contracts to be reviewed, and greater overall process efficiency. Where contract standardization isn’t feasible, work to standardize contractual clauses. Non-standard clauses can be flagged for escalation and approval, which will help streamline the revenue accounting process and focus attention on high-dollar deals.
Other top concerns in implementing the new standard were Developing and Implementing New Accounting Policies (76%), Documenting the Conversion Process and Associated Auditability (76%), and Quantifying Adjustments (72%). The key here is that many companies don’t realize just how much of an issue these will be until they begin applying the new guidance. With the effective date just around the corner, it’s time to develop a plan to address these challenges.