In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers (Topic 606) for public business entities, certain not-for-profit entities, and certain employee benefit plans. It becomes effective for public entities for annual reporting periods beginning after December 15, 2017. In addition to changing things dramatically in the accounting and financial realms, this new revenue recognition standard which may significantly impact the compliance profession, compliance programs and compliance practitioners going forward. In this episode, we consider how you should set your transaction price.
Matt Kelly and I have put together a five-part podcast series where we explore implications of this new revenue recognition standard. Each podcast is short, 11-13 minutes and deals with one topic on the new revenue recognition standard. The schedule for this week is:
Part 1: Introduction
Part 2: What the logic of your transaction price?
Part 3: Shaking up software revenue recognition.
Part 4: Auditors need to pay attention.
Part 5: What does it all mean for compliance (and everyone else)?
FASB states that Step 3, determine the transaction price, is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties. To determine the transaction price, an entity should consider the effects of:
- Variable consideration – If the amount of consideration in a contract is variable, you must determine the amount to include in the transaction price by estimating either the expected value or the most likely amount.
- Constraining estimates of variable consideration – An entity should include in the transaction price some, or all, of an estimate of variable consideration only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur.
- The existence of a significant financing component – An entity should adjust the promised amount of consideration for the effects of the time value of money if the timing of the payments agreed upon by the parties to the contract provides the customer or the entity with a significant benefit of financing for the transfer of goods or services to the customer.
- Noncash consideration – If a customer promises consideration in a form other than cash, an entity should measure the noncash consideration at fair market value.
- Consideration payable to the customer – If an entity pays, or expects to pay, consideration to a customer in the form of cash or items, such as a credit, a coupon, or a voucher, that the customer can apply against amounts owed to the entity, the entity should account for the payment as a reduction of the transaction price or as a payment for a distinct good or service, or both.
Kelly noted all of this means judgment are going will become more important under the new revenue recognition standard. He said “People should be thinking about that judgment means, who will be able to defend, precisely how your organization is defining the transaction price. That is something that your audit firm will want to look at and you should understand that the audit firms have more pressure to be more skeptical about judgments their clients make.”
One particular problem could be non-cash transactions or even consideration. He advised to think “about the difference between cash and non-cash compensation for a deal. What if some of your payment for a transaction was in Bitcoin; the value of which is literally changing by the day right now. You could have a transaction that you agree to payment on the first of the month and some part of it might be conveyed in Bitcoin at the end of the month. However, the value of bitcoin could change dramatically before the end of the month or the quarter. Further, compensation can come in many forms, such as receipt a patent from a joint venture partner, travel voucher or really anything of value. It will create a requirement to accurately value them and implement that valuation.
An ancillary result will be that many non-accountants are going to find that they get pulled into these conversations that you probably have not had much experience with before over revenue recognition. Lawyers and compliance practitioners, for instance may well be a part of these conversations going forward. They typically have not been a part of the discussion to determine the transaction price in the past. That is really going to be the tricky part of defining what a transaction is under this new revenue recognition standard.
For the compliance practitioner, it is not simply being able to read a spreadsheet anymore. It is understanding the underlying basis of that spreadsheet and are those underlying bases defensible. Consider in the FCPA and greater compliance ream, you may be required to justify the values assigned to either discounts, rebates or some other form of payment variance. In the overall context of an FCPA investigation, under the books and records provisions, a compliance professional may well have to take a much more detailed view of this to determine the transaction price when you sit down across the table from somebody at the DOJ.
Kelly concluded, “in the grand scheme what FASB wanted to achieve with this new revenue recognition standard was to bring more transparency to the logic of the economic action.” You will need to be able to justify where did these numbers come from related to this business transaction the companies are engaged in going forward. It is certainly going to be a very different world for some people.
I hope you will continue to join us for our exploration this week. Tomorrow in Part III, we will explore how this new revenue recognition standard will shake up the software industry.
Determing the transaction price will impact many groups not previously a part of the revenue recognition process.Click to tweet