Many companies have been diligently working through the details of the FASB’s Accounting Standards Update (ASU) 2014-19, Revenue from Contracts with Customers (Topic 606). This standard is effective for nonpublic organizations for annual reporting periods beginning after December 15, 2018. A few topics might require extra attention from management, including how to identify new contract assets and liabilities, and how this standard will affect the processes and controls of revenue recognition.
The new revenue recognition standard includes guidance related to contract assets that is a major change from legacy GAAP. The major difference is the ability to now capitalize costs to obtain a contract and amortize over the life of that corresponding contract. Legacy GAAP would have companies expense those costs in the year that was incurred, so this new standard has the possibility of a new “contract asset” being recorded on the company’s balance sheet.
The rules to capitalize these costs are relatively straightforward; these costs must be incremental or a cost that was incurred as a result of obtaining a specific contract. The best and most common example of an incremental cost would be sales commissions; these costs would not be incurred if a contract is not finalized. If your company has these types of costs, it would be worth taking the extra time to evaluate this concept to determine whether a material change could be present as a result of this new standard.
An additional major consideration is to evaluate whether new contract liabilities exist as a result of implementing the new standard. The new standard introduces the concept of a material right. Some examples of material rights could include offering sales incentives, loyalty programs or discounts to customers.
For a material right to exist, these offerings would need to exist only to the customers that are entering a specific contract, so marketing offers would be excluded from consideration. As an example, think about this as if your customer is paying in advance for future goods or services, so this contract liability is much like deferred revenue, in comparison. These considerations might require some additional time and effort to identify. If your company offers incentives to customers, be sure to reach out to your trusted advisor to determine if contract liabilities exist.
There has been a lot of talk about factors that will drive additional costs that a company might incur as a result of adopting this new standard. The key consideration that might drive cost is how this standard will affect your company’s internal control processes and controls.
Considerations for items like capturing contract assets and liabilities, such as contract costs or material rights, will need to be dealt with using a process that will most likely be different than your current process.
Make sure to take time for these considerations to ensure that efficient and effective controls are designed and implemented at your organization. This will help lessen the cost and burden of this comprehensive standard.