Revenue Recognition Standards May Affect Even Simply-Structured Businesses

When I began my initial review of the new revenue recognition literature, I expected that some industries like technology, construction, telecommunications and software would see significant consequences to their financial reporting because of changes to the standards. I kept telling myself, though, that some businesses wouldn’t be impacted very much at all. I thought the consumer products industry, for example, could expect only a few changes to its current operating practices and financial reporting. 

On the surface, I was right. The model is straightforward. A company ships an order to a customer, and, once the customer accepts the products, the company recognizes the revenue. If there is a right of return in place, then the company has to take it a step further in estimating returns, but it has years of experience doing this. So, all in all, it seems fairly simple. 

But the devil is in the details. As I began to consider what else the company in the example above could offer its customers, I ran into some serious issues. The company could offer promotional programs, volume discounts and warranties.  It also could have licensing arrangements with its customers, as well as arrangements with its distributors. And, under the new standard, the company would also need to look at its shipping terms with customers to determine if protection of goods during transportation is a separate performance obligation.  Revenue recognition just went from a simple accounting process to a three-month evaluation and documentation project in a matter of minutes.

I also began to think about volume rebates.  If there is variability in pricing, the new standards will require companies to estimate pricing based on either an “expected value” approach or “most likely amount” approach.  The expected value approach is a probability-weighted model, and the most-likely approach is based on management’s best estimate.  In addition, you can only record as revenue an amount that would not result in a significant reversal of revenue in a future period. And, of course, you will be required to update your estimate each reporting periods for new facts and circumstances. 

And the new standard’s impact isn’t limited to financial-reporting. We will also see changes in information technology systems and processes, tax compliance, and compensation arrangements, to name a few   Most of us have considered the impact on the IT front.  But now, we are beginning to see more discussion about tax compliance and complexities around IRS filing requirements. 

Certainly the objective of the taxing authorities is to increase reportable revenues, thus increasing tax dollars.  It will be critical to have your tax professionals evaluate any and all alternative tax accounting methods.  In addition, with the new revenue recognition standard likely resulting in increased deferred revenues, you will need to put processes in place to track the increased timing differences.   From a tax standpoint, the biggest areas where these timing differences may occur in the consumer products industry would be related to long-term contracts and arrangements involving advanced payments.

Consumer products companies will also need to revisit their compensation plans as a result the new standard.  Sales commission plans and performance-based stock awards are often significant to the operations of consumer products companies and will very likely be impacted by the new standard.  Companies should carefully evaluate the new standard to ensure it doesn’t negatively impact their compensation plans.

So, my first assumption – that the new revenue recognition standards won’t affect businesses with simple structures – was a bit shortsighted. Using a simple consumer products company as an example, I’ve identified a number of areas where the new standards could require significant changes.

It isn’t too early to begin assessing  the impacts of the new revenue recognition standard on your  business. I will continue to brainstorm ways this new guidance could impact businesses across all industries, and will share my insights in future Waypoints blogs.

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