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Understanding Variable Consideration and The Time Value of Money

by Jagruti Solanki on May 9, 2016

With the new revenue recognition standards upon us and adoption for public entities right around the corner, we’re finding that two aspects are tripping our clients and prospects up more than any other - variable consideration and the time value of money.

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New Revenue Recognition Standard Update PWC

FAQ'S

[fa icon="plus-square"] What is Revenue Recognition?
  1. Link the contract with a specific customer. There is usually a written contract that defines a financial payment, though it is not necessary to have a written contract; an oral arrangement can be used as the basis for revenue recognition.
  2. Note the performance obligations required by the contract. A performance obligation is essentially the unit of account for the goods or services contractually promised to a customer. The performance obligations in the contract must be clearly identified. This is important in recognizing revenue, since revenue is considered to be recognizable when goods or services are transferred to the customer.
  3. Determine the price of the underlying transaction. This step involves the determination of the transaction price built into the contract. The transaction price is the amount of consideration to be paid by the customer in exchange for its receipt of goods or services. The transaction price does not include any amounts collected on behalf of third parties.
  4. Match this price to the performance obligations through an allocation process. The basic rule is to allocate that price to a performance obligation that best reflects that amount of consideration to which the seller expects to be entitled when it satisfies each performance obligation. To determine this allocation, it is first necessary to estimate the standalone selling price of those distinct goods or services as of the inception date of the contract. If it is not possible to derive a standalone selling price, the seller must estimate it.
  5. Recognize revenue as the various obligations are fulfilled. Revenue is to be recognized as goods or services are transferred to the customer. This transference is considered to occur when the customer gains control over the good or service.
[fa icon="plus-square"] What Are the Transition Methods?

For both public and nonpublic entities, three basic transition methods are available —1full retrospective, retrospective with certain practical expedients, and a cumulative effect approach.

[fa icon="plus-square"] When Does The Standard Become Effective?

Public entities will apply the new standard for annual periods beginning after December 15, 2016, including interim periods therein. Early adoption is prohibited. Therefore, a calendar year-end public entity would reflect the new standard in its March 31, 2017 first quarter, each subsequent quarter, and also in the year ending December 31, 2017.

Nonpublic entities have an additional year to adopt, i.e., the new standard applies for annual periods beginning after December 15, 2017. In addition, the new standard is effective for interim periods within annual periods that begin after December 15, 2018. Therefore, a calendar year-end nonpublic entity would first apply the new standard for the year ended December 31, 2018. If it also prepares interim financial statements, the new standard would first take affect for those interim periods in 2019.

[fa icon="plus-square"] What Does the New Standard Require?

The revenue standard’s core principle is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled.

5 Step Approach

1. identify the contract with the customer
2. identify the performance obligations in the contract
3.  determine the transaction price
4.  allocate the transaction price to the performance obligations in the contract
5.  recognize revenue when (or as) the entity satisfies a performance obligation.

[fa icon="plus-square"] What Industries Are Impacted?
[fa icon="plus-square"] How Will We Be Impacted?

The following areas may be significantly impacted:

  • Judgements & Estimates
  • Compensation based on Revenue - Related Metrics
  • Covenants
    Contract Terms
  • Income Tax Effects
  • Internal Controls
  • Communications with Stakeholders
[fa icon="plus-square"] What Should We Be Doing Now?

Management should familiarize itself with the new standard and begin evaluating its potential impact on each specific revenue stream of the entity, such as the sale of goods vs. the provision of services.

  • Additional investments in training for financial reporting professionals may be necessary.
  • Monitor the activities of the AICPA and the Transition Resource Group, as discussed below. This may be particularly relevant for matters involving a high degree of judgment, where previous U.S. GAAP may have been more prescriptive.
  • Management should begin considering the available transition methods. Conversations with the company’s financial statement users and also peer companies may be useful for this purpose. Further, the SEC staff is expected to address how transition under the new standard will affect the five-year selected financial data table for SEC registrants.
  • Public entities will need to begin drafting SAB 744 disclosures about the anticipated effect of the new pronouncement. While these disclosures will become more specific over time, the SEC staff has informally indicated it expects entities to disclose their chosen method of transition in the period that a decision is reached, which will vary across entities.

 

[fa icon="plus-square"] What Resources Are Available?

FASB/IASB Joint Transition Resource Group – The TRG was designed to discuss emerging issues and to inform the Boards about interpretive questions that are likely to arise as implementation efforts commence. 

Softrax - Has over 15 years of working with companies trying to bring their business up to speed with the latest guidance, we're happy to offer a modular, open-ended solution that can handle new revenue recognition needs without the need to change or replace the systems your company most relies on. We can even help you understand the potential impacts to your accounting processes, working with you to develop an implementation strategy that ensures your business is ready to meet the challenges of ASC 606 and beyond.

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