Though it has been publicized that certain “contract-based” industries – telecommunications, technology, engineering, media, and pharmaceuticals, to name a few – will be impacted by the new revenue recognition rules the effects are in fact more far-reaching and will apply to all companies, public or private. A 15-year effort made by FASB and the International Accounting Standards Board has resulted in significant revenue recognition changes which will take effect in January 2018. The changes outlined in Accounting Standards Update 2014-09 will have sweeping effects as to how and when businesses recognize revenue for financial statement reporting purposes.

The objective of the new rules is to create a single global revenue recognition model applicable across all industries. This principles-based model has five steps: (1) identifying applicable contracts with customers; (2) identifying performance obligations within those contracts; (3) determining the total transaction value; (4) allocating the transaction value to those performance obligations; and, (5) recognizing revenue as your company satisfies those performance obligations.

Manufacturing, distribution, and retail companies may initially consider their sales model too simplistic but likely haven’t contemplated the potential implications to their industries. The following are examples of scenarios that will change revenue reporting in January 2018:

  • Multi-year manufacturing arrangements – Manufacturers that fulfill multi-year orders, produced to customer specifications, could be required to recognize revenue on work in progress. Under present GAAP, manufacturers recognize revenue only when goods are shipped or delivered. Under the new rule, contracts entitling manufacturers to a right of payment for work to date will now require revenue recognition over time, as products are completed, rather than shipped.
  • Manufacturing incentive payments – Manufacturers entitled to an incentive payment at the end of a multi-year contract may now need to consider the incentive payment as part of a transaction value. Under the new rule, to the extent it is probable that the manufacturer will collect the incentive payment; portions of it will be recognized rateably over the life of the contract, not at the date the manufacturer is entitled to the payment.
  • Customer loyalty programs, reward points – Under the new revenue rule, customer incentives, commonly offered by retailers and distributors, may give rise to separate performance obligations that affect the timing of revenue recognition. Incentives entitling customers to additional goods or services for free, or at a discount, that would not have been received without entering into the contract are deemed separate performance obligations, thereby requiring an allocation of a portion of the transaction price to the incentives.
  • Volume discounts, price concessions, rebates – Under the new rule, sales incentives that create variability in the price of the goods or services offered to the customer will now require companies to employ certain predictive methods to determine the amount of consideration they are entitled to. Judgments made in determining the true transaction price could prove challenging due to issues such as subsequent changes to estimate inputs that could result in a reversal of revenue, susceptibility to factors outside the entity’s control, and business practices that offer a multitude of possible transaction prices.

Ultimately, the new revenue recognition standard starts with the contract and the obligation(s) it creates. In some cases defining those factors will be black and white; in others, they will be gray. At a minimum, the change requires management to re-examine and assess their earnings process and how ASU 2014-09 could impact their financial statements.