Top 10 Revenue Recognition Misconceptions
In previous revenue recognition articles, we have focused on various topics concerning the new standard, most recently ASC 606’s tax impacts. While there are many more topics to cover, we thought it timely to address some misconceptions that we have seen when talking to our clients and others about ASC 606 implementation. Today, we’re going through the top 10 revenue recognition myths and what your organization can do to prepare for ASC 606.
Misconception #1: Revenue Recognition Implementation Can Be Done Quickly
Implementation will be time-consuming and require focused periods of time and effort. Because of how complicated and involved revenue recognition is, implementation of ASC 606 can rarely be fully addressed quickly. Therefore, to ensure adoption deadlines are met, organizations will need to put effort into the planning phase of their revenue recognition project. What we’ve seen at Wipfli is that organizations (and especially private businesses) are all over the map in terms of planning and creating viable timelines. We’ve seen that implementation is taking on average from three to 12 months, for simple to moderately affected clients.
It naturally depends on the complexity of your situation and how many resources you have available in-house and externally. Creating timelines is so important because you cannot assume outside resources will be available when you are ready, and don’t forget that your in-house resources already have full-time jobs. Identifying internal stakeholders and what internal and external resources you will need in advance, as well as creating a realistic timeline, are all extremely important to ensuring a smooth revenue recognition implementation.
Misconception #2: We Don’t Need to Involve Auditors Until the End
The new revenue recognition standard is just that: new to everyone, including auditors. Plus, it requires a significant amount of estimation and judgment, creating further complexity. This means you will want to consult auditors early and often during the adoption process so that you can agree on the scope of the project, its requirements, its timelines, who will be involved and the results of the analysis phase. This allows you to avoid surprises come audit and tax time, as well as avoid missed deadlines.
Misconception #3: We Don’t Need to Consider This for Budgeting Purposes
Because your internal resources already have their core responsibilities, the chances of you having to look to outside resources to effectively implement revenue recognition are high. This, of course, affects your budget from both a time and money perspective. In fact, many companies have said they underestimated what’s involved in identifying, recording and tracking the data needed to successfully implement the standard. And when you don’t involve resources like your tax advisors in revenue recognition, that can add to budget costs because you need to fully understand how it affects tax reporting and other tax issues.
Ultimately, you need to consider whether you have the internal resources, such as IT, needed to ensure a successful adoption and whether those resources have time to participate in this process. If the conclusion you reach is that you will require outside resources, you need to adjust your timelines to reflect the resource selection and scoping phases before you finally are ready to begin your revenue recognition implementation.
Misconception #4: The Standard Will Have No Impact on Us
The new revenue recognition standard has a more robust framework for reporting consistency, which means you must go through all five steps of 1) identifying contracts with customers, 2) identifying performance obligations, 3) determining the transaction price, 4) allocating the transaction price to the performance obligations and 5) recognizing revenue when or as performance obligations are satisfied.
Many organizations are surprised at what comes out of this five-step process. The worst thing you can do is skip over the terms and conditions of a contract because you don’t think they’ll impact revenue recognition. This will most likely result in issues identified on the back end, causing compressed timelines. In implementing ASC 606, contracts need to be analyzed through all five steps to determine the impact and correct method of recording and disclosing revenue recognition.
Misconception #5: The Information Needed Is Readily Available
Unfortunately, it often turns out that the information you need to implement revenue recognition is not readily available. Because the standard relies heavily on judgment, it requires observable inputs derived from a variety of data points that may be stored in disparate systems or may need to be created because it was never tracked in the first place. Again, it’s what makes planning and resource allocation so important.
Misconception #6: I Don’t Expect the Impact to Be Material, So I Can Ignore It
The materiality principle states that an accounting standard can be ignored if the net impact of doing so has such a small impact on the financial statements that a reader of the financial statements would not be misled. However, judgments made about materiality need to consider both quantitative and qualitative factors at the financial reporting level (when deciding on the scope of your revenue recognition efforts) and at the individual contract level (when assessing separate performance obligations).
Quantitative factors include taking into consideration individual revenue streams compared to gross revenue. Qualitative factors include the potential effect of the misstatement on trends, especially in profitability; loan compliance; recurring earnings; the likelihood that a misstatement that is currently immaterial may have a material effect in future periods and at the contract level; and the relative significance or importance of a good or service to the entire arrangement. Whatever the case, you need to analyze the potential impacts and back up your materiality conclusions with data points to ensure you’re reporting in line with generally accepted accounting principles (GAAP).
Misconception #7: ASC 606 Only Impacts Finance
While the results of revenue recognition are measured and reported by Finance, it’s the activities of the other departments that directly impact those results. For example, marketing campaigns or negotiations between a sales representative and a customer that promise future discounts, free services or products, or make guarantees, can impact the number of goods or services identified in a contract as well as the timing of revenue recognition. Other examples include the drafting and approval of contract terms and conditions by the legal department and employee incentive plans developed by the human resource department.
One of the best things you can do is train your employees on the potential impact their actions can have on your company’s revenue recognition. Therefore, collaboration and communication with every department in your company will be key to ensuring a successful adoption of the new revenue recognition standard.
Misconception #8: We Can Handle Our Own System Conversions or Will Manage Through the Use of Spreadsheets
Many organizations already leverage automation in their revenue recognition process, while others rely heavily on the use of spreadsheets. For those organizations that are greatly impacted by the new standard and/or have a lot of open contracts at year-end, spreadsheets may become more difficult and time-consuming to maintain. Spreadsheets are especially difficult for multiyear contracts that require the deferral of income and or the capitalization of contract costs. Not to mention the fact that the new standard requires expanded footnote disclosures, which may require new or expanded data sets that are currently not being tracked.
And for those organizations that already leverage automation, depending on the internal IT project lists and internal-resources available, they may need to consider leveraging outside resources to ensure they can meet adoption deadlines. Once again, planning will be key in adopting the standard so that information flows through the system and provides internal users, as well as external auditors and tax advisors, with the information they need.
Misconception #9: Either My Accountants Will Draft the Expanded Footnote Disclosures or We Can Copy From Companies That Have Already Adopted ASC 606
Because public companies are usually first adopters, others often look to them for examples. However, this can result in inaccuracies since organizations’ footnote disclosures are required to reflect the economics and fact patterns of their specific revenue recognition practices. If you’re a private company, you can certainly review the disclosures of public companies, but then you will need to customize the disclosures to fit your company and the estimations and judgments involved in your company’s revenue recognition policies. It simply will not work as a cut-and-paste from a public company’s disclosures.
Additionally, private companies have been given a reprieve on a good portion of the robust disclosure requirements required of public companies, so don’t do more work than you need to.
Last, as discussed throughout this article, new and/or expanded data sets may be required, which may or may not be readily available. This again will require organizations to plan before reporting deadlines, as well as understand the changes expected, the information required and the people available to assist with this effort. Is it reasonable to expect your CPA to be responsible for all of this without your help? The footnote disclosures along with the financial statements are the responsibility of the company, and you must budget time for addressing changes in reporting and disclosure.
Misconception #10: Once I Adopt ASC 606, I Will Not Need to Address It Again
Every time you alter your organization’s standard terms and conditions, accept a customer’s terms and conditions, change your business model or offer new goods and services, you will need to go through the five-step revenue recognition process again. In addition, you must consult ASC 606 when accepting contract modifications to existing contracts. All of this means that the most important thing you can do is create a sustainable and well-documented revenue recognition model that will allow you to make changes in your organization going forward.
Getting Started With Revenue Recognition
If you have further questions about revenue recognition or need outside resources to help implement this new standard, contact Wipfli. We know ASC 606 is complex, and we’re here to help your organization through a smooth, successful implementation.