By Richard Koch, CPA
Director of Quality Control at Gray, Gray & Gray
If your company has contracts with customers, the way you recognize (for accounting purposes) the revenue generated by those contracts has changed. This is an important issue for businesses in a range of industries, including construction, SaaS, and other subscription-based services.
Accounting standards call for revenue to be recognized when it is realized and earned. This poses a problem for contracts that may take several months or years to complete. At what point during the term of the contract do you recognize revenue?
The core principal of the new standard is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled to exchange for those goods or services. An entity recognizes revenue in accordance with that core principal by applying the following steps:
- Step 1 – Identify the contract(s) with the customer;
- Step 2 – Identify the performance obligations in the contract;
- Step 3 – Determine the transaction price;
- Step 4 – Allocate the transaction price to the performance obligations in the contract; and
- Step 5 – Recognize revenue when (or as) the entity satisfies a performance obligation.
In some cases, a business will combine contracts and account for them as one contract. Performance obligations must be accounted for separately if the goods or services transferred to the customer under the contract are distinct. As a practical expedient this guidance may be applied to a portfolio of contracts (or performance obligations) with similar characteristics if the seller reasonably expects that the financial statements would not differ materially from applying the guidance to the individual contracts or performance obligations within the portfolio. The transaction price may be fixed or variable; and is typically allocated to each performance obligation on the basis of the relative standalone selling prices of each distinct good or service promised in the contract.
Private (non-publicly traded) companies must apply the new revenue standard (ASC Topic 606) for the annual reporting period beginning after December 15, 2018. This can be a complex and time-consuming process. It is important that you meet with your accountant or independent auditor as soon as possible to make sure you are meeting this new reporting obligation.
If you have questions about revenue recognition or other accounting questions, please contact Richard Koch at (781) 407-0300 or via email at firstname.lastname@example.org