Questions You Should Be Asking About Revenue Recognition

When I talked with folks here at HORNE about the topic for this post, FAQs on the new revenue recognition standards, I asked them what questions they were getting about the implementation process for the new rules. After a few conversations, it became clear that we were much more likely to come across revenue recognition issues in the course of other discussions with clients. We really haven’t been asked much about the new standard from private companies. Currently, most questions relate to infrequent transactions or the impact of new sales contracts.

With that in mind, here are some frequently asked questions and answers on the topic of revenue.

Q: How do we treat that big sales contract that includes multiple service offerings?

A: We enjoy hearing about great wins for our clients. Often, clients want to show as much revenue on the books as quickly as possible. Under the new standard, businesses must continue evaluating the separate obligations that they must perform under the contract, allocate the revenue among the obligations, and recognize the revenue as the obligations are met.

Q: Will this new standard significantly change our top-line revenue number?

A: For most industries, the standard shouldn’t necessarily result in a significant change in revenue. It’s designed to take all of the industry-specific guidance that has existed until now and combine it into a one-size-fits-all approach that will make revenue numbers more comparable between industries. A few industries, particularly technology and telecommunications, might see more significant shifts. For most businesses, it’s likely that the standard will affect processes and internal controls but not result in a significant change to top-line revenue.

Q: How are returns and warranties treated under the new standard?

A: In most cases, the business offering a right of return or a warranty has a pretty good idea of what percentage of products will be returned or repaired. Even in the absence of specific numbers based on the history of the business, there may be other information available to assist in the estimation process. In most cases, the accounting treatment for returns and warranties will not change under the new standard.  If the numbers indicate that 15% of product is likely to be returned, that is recorded against the revenue as it is recognized. Companies will need to be careful under the new standard as it stresses the principal of no significant revenue reversal.  One slight change for companies could be the requirement to record an asset for product returns rights (subject to impairment) and a liability for the obligation.

Similar to product returns, the new guidance is expected to change the accounting for warranties to the extent companies are not promising anything beyond the product specifications. Companies should reevaluate their warranties to ensure they are not promising any beyond the agreed-upon specifications.  

Q: How are “nonrefundable” up-front payments treated?

A: Even though the customer may have given up the right to a refund on the payment, the business can’t necessarily recognize the revenue until it meets obligations under the contract. Significant judgement is required under existing guidance and will need to continue to under the new guidance.   While some businesses may want to immediately recognize the nonrefundable payment as revenue, careful consideration must be given to whether the payment is actually for a future service or obligation.  Along with determining whether companies should defer the payments comes the question of how long.  Again, significant judgement must be applied as the deferral period will often match the period the services are to be provided. 

This is by no means an exhaustive list of all of the questions that businesses have about the revenue recognition. In fact, many of the questions that we get are very fact-specific that may affect just one or two clients. Meanwhile, many companies continue to delay addressing the new disclosure requirements, treating them as a minor detail that can be quickly and easily addressed. That’s a mistake. The worst thing you can do is wait too long and become overloaded with the implementation of these comprehensive standards at the last minute.

This reminds me of my daughter. The older she gets, the more she is living by the motto that sometimes “it’s easier to ask forgiveness than permission.” But if there’s one thing to remember about revenue recognition, it’s that permission costs a lot less than forgiveness. We certainly don’t want to come across as “helicopter parents” to our clients. But when it comes to revenue recognition, an ounce of planning with us up front could save you from pounds of penalties in the future. Please reach out to our Public and Middle Market team for answers to your questions and for help in planning your transition to the new revenue recognition standard.

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