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By J. Gregory Kashella, CPA

With businesses adopting the Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 606, Revenue with Contracts from Customers, CPA firms are confronted with the task of assisting small-business clients who usually do not have the staff experienced in technical accounting matters. The purpose of this blog is to provide a discussion of major provisions within the standard to help with implementation as it applies to small, nonpublic businesses.

Prior to the adoption of ASC Topic 606, most revenue recognition notes for small companies went like this: “The company recognizes revenue when earned rather than when cash is received … .” Under the new standard, the FASB is asking, “What do you mean by ‘earn revenue’?” Consequently, new measurements, new terminology, and more extensive explanatory disclosure requirements were developed for the standard.

Below are a few steps to adopt and adapt to the standard.

Determine if the company must change anything with its methods of recognizing revenue – The new standard centers around identifying various contracts with customers and how the company fulfills its performance obligations. The biggest question in the standard is when does the customer take control of the product or services, thus fulfilling the performance obligation? Most small companies, due to the simplicity of their transactions (selling items, servicing items, or selling services) will not see material changes in the timing or amount of revenue recognized. The largest change for smaller companies likely will be terminology and disclosure requirements.

Learn the new terminology – ASC Topic 606 employs new language to describe what is already known. “Earning revenue” is replaced with, “fulfilling performance obligations.” Under the standard, a company fulfills its performance obligation when control of the product or service passes to the customer.

Other new terminology includes the following:

• Transaction price – The price the company charges for its products or services or consideration the company expects to receive.
• Contract assets – Examples are accounts receivable, notes receivable (related to sales transactions), and costs in excess of billings. Another type of contract asset is one that exists because the company fulfilled its performance obligation but is not permitted to bill the customer. This most often occurs in government contracts where the project must be approved after it is completed.
• Contract liabilities – Examples are customer deposits, deferred revenue, and billings in excess of costs

Include the required disclosures – Disclose how the company fulfills its performance obligations and when billing is done. This includes disclosing if the performance obligations are satisfied at a point in time, over time, or both. For example, “The company sells general merchandise and considers its performance obligations fulfilled at the point in time when the customer takes possession of the merchandise. Customers are billed at the time possession is taken.” An example of a firm that would recognize revenue at both a point in time and over time is a law firm. If the law firm does a simple will for a client, it will most likely recognize revenue at the point in time when the document is completed and the client takes possession of the document. If the law firm consults for a construction project, the firm may recognize revenue when the environmental permits are obtained, then when the site plans are approved, then again when other parts of the project are considered fulfilled.

Disclose how the transaction price is determined – This disclosure will include factors taken into consideration when products are priced, such as the cost of the merchandise plus an appropriate mark-up.

Disclose that management judgement is involved – This is something inherently obvious but is required. The disclosure will include that management’s judgement is required when determining the transaction price; in cases of revenue earned over time, judgement is involved in the amount of costs and revenue to be recognized. Another obvious disclosure concerning judgement is that these judgements can change the amount of revenue and profit earned in the period.

Disclose disaggregated revenue – For a company that has more than one revenue stream, the various sources of revenue must be disclosed. For private companies, it is not required to quantify the different revenue streams as it is with public companies.

Disclose the composition of the company’s contract assets and liabilities, and disclose the change in those balances during the year – This can be done by disclosing the amount of change each year in narrative form or in table form showing the opening and closing balances of each component. If the table method is used, it is important to note that for single-year financial statements both the year-end contract assets and liabilities balances and the balances at the end of the previous year must be disclosed. For two-year comparative statements, three separate amounts must be disclosed: end of current year, end of previous year, and beginning of previous year.

Considering all of this, I have the following suggestions to assist in implementation of the standard.

First, get into the standard itself. The FASB offers free subscriptions to the codification, and many accounting research services contain materials on the codification.

Second, attend CPE courses. The PICPA offers numerous courses and webinars on the subject. 

Third, read public company financial statements. Public companies publish their annual reports on the internet. Since public companies are required to adopt new accounting standards ahead of private companies, these reports are a good source of information. Read the section on revenue recognition. See how the company describes how it fulfills its performance obligations, examine the management judgement wording, the transaction price wording, and the wording of the various other parts of the standard.

J. Gregory Kashella, CPA, is the financial statement technical review manager with Smoker Smith & Associates PC in Hershey and is a PICPA Key Contact Person to the U.S. Congress. He can be reached at GKashella@SmokerSmith.com.

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