Not since Sarbanes-Oxley in 2002 has the Financial Accounting Standards Board issued such sweeping changes to generally accepted accounting principles (U.S. GAAP). But changes are coming, and they’re only a year or two away. ASC 606, Revenue from Contracts with Customers, has been proposed, debated, amended, and finalized. Now, it’s time for companies to get serious about implementing it. If you’re an executive, here’s what you need to know about preparing your organization for the change.
At its most basic level, the new standard moves revenue recognition from industry-specific, rules-based guidance to a principles-based approach. The latter requires more judgment, more estimates, and, in many cases, more aggressive revenue recognition than current U.S. GAAP.
ASC 606 applies to your company if you report on an accrual basis and have contracts with your customers that are not insurance contracts, lease agreements, and certain other financial services agreements.
When it Matters
If you’re a public company, ASC 606 becomes effective starting with Q1 2018 reporting. Private companies get an extra year and must comply beginning in 2019. Depending on the adoption method you choose, however, you will also have to apply the guidance retrospectively to 2016 and/or 2017, so for most companies, it matters right now.
What Your Team Should Be Doing Now
Determining areas of impact
The new standard will affect more than just your financial statements. Your accounting procedures and internal controls around revenue will likely need to be revamped, considering the increased degree of management judgments and estimates required. Tax planning strategies will change if earlier recognition of revenue becomes necessary. You may have debt covenants and other legal agreements that will be impacted by changes in revenue measurements. And your ERP system will need to be reassessed to determine if any data capture or reporting customization may be necessary to comply with new disclosure requirements.
Evaluating operational and performance metrics and compensation plans
Before you begin budgeting and forecasting for 2018/2019, think about how the changes will affect company performance assessments and employee compensation. Your existing processes for projecting revenue may produce different trends and recognition patterns than you will see under the new standard. You may also need to revisit commission and bonus structures that are revenue-dependent. The new standard requires that variable consideration be estimated and included in the transaction price at contract inception. Will your comp plans follow the same pattern or will you withhold commissions and performance bonuses until the related revenue becomes definite?
Choosing an adoption method
Companies may choose from two adoption methods. The full retrospective method requires restatement of the financials for all periods presented, while the modified retrospective method requires only a cumulative adjustment to beginning retained earnings in the year of adoption. But certain disclosure requirements may make the modified retrospective method less feasible for smaller companies. It’s a more complex decision than it seems, but the sooner you make it, the more smoothly your implementation is likely to go.
Preparing your stakeholders
Your accounting team will need to be properly trained regarding the standard and any new duties or responsibilities. And, as previously discussed, employees whose compensation depends on revenue calculations should be informed in advance of changes to their comp plans.
You’ll also want to prepare your board and investors for changes to your financial statements and key performance indicators. Particularly in the year of adoption, the restatement of revenue and certain expenses from prior periods may cause confusion for those who haven’t been looped in ahead of time. The presentation of pro forma financials and related schedules may help alleviate this problem.
At 9Gauge, we’re always looking for new ways to be of service to our clients. You’ll see more about ASC 606 on our blog as we discuss the key aspects of the standard and how it differs from current requirements. When you’re ready to talk through implementation solutions for your company, we’ll be here to guide and support you through the process. Click here to contact 9Gauge.