Revenue recognition: Lessons learned from an early adopter
INSIGHT ARTICLE |
In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2014-09, Revenue from Contracts with Customers (Topic 606), which added Topic 606 to the FASB’s Accounting Standards Codification (ASC) and will replace almost all pre-existing revenue recognition guidance in legacy generally accepted accounting principles (GAAP) with a robust framework for addressing how an entity should account for its revenue. Implementation by calendar year-end public entities must occur no later than January 1, 2018 and by other calendar year-end entities no later than the year ending December 31, 2019.
While the FASB provided delayed effective dates for ASC 606, it was with the understanding that implementation of that guidance would be a significant undertaking for many (if not most) entities. With three years having passed since initial issuance of ASC 606, entities should be well on their way to assessing how it will affect their revenue recognition policies and disclosures and developing an implementation plan. This is particularly true for public entities, companies that plan to elect the full retrospective transition method and companies that have multi-year contract terms with their customers.
A case study: General Dynamics
One such public entity with multi-year customer contract terms that elected the retrospective transition method in its adoption of ASC 606 is General Dynamics1. This Fortune 500 Company is a global aerospace and defense company offering a broad portfolio of products and services in business aviation; combat vehicles, weapons systems and munitions; information technology services and command, control, communications, computers, intelligence, surveillance and reconnaissance solutions; and shipbuilding and ship repair. It accounts for revenue under legacy GAAP using the percentage-of-completion method.
As a result of its implementation of ASC 606, General Dynamics reported two primary impacts in its 2016 Form 10-K:
- The total impact of an adjustment in estimated profit recorded to date on a contract will be recognized in the period it is identified (cumulative catch-up method), rather than recognizing the impact of an adjustment prospectively over the remaining contract term. As a result, adjustments in contract estimates may be larger and likely more variable from period to period, particularly on contracts of greater value and with a longer performance period.
- For its contracts for the manufacture of business-jet aircraft, General Dynamics will record revenue under ASC 606 at a single point in time when control is transferred to the customer, generally when the customer accepts the fully outfitted aircraft. Prior to the adoption of ASC Topic 606, General Dynamics recorded revenue for these contracts at two contractual milestones: when green aircraft were completed and accepted by the customer and when the customer accepted final delivery of the fully outfitted aircraft.
Although the financial impact of the adoption of ASC 606 will be different for every company, General Dynamics’ disclosures in its Form 10-K demonstrate it is important to provide transparency for investors by focusing on the material effects using plain-English verbiage. There are certain required disclosures for the adoption of a new accounting standard, but it is interesting to note that General Dynamics also anticipated possible investor questions about the adoption of ASC 606 by providing additional disclosures, such as explanations about:
- What financial statements will look like in the coming year under the new standard (e.g., whether the impact of adoption will or will not be representative of the impact of the standard on subsequent years’ results)
- Whether ASC 606 changes the total revenue or operating earnings recognized, or whether it only changes the timing of when those amounts are recognized (i.e., reassurance that ASC 606 does not affect a contract’s cash flows)
How was General Dynamics in a position to early adopt ASC 606?
General Dynamics is one of just a handful of public entities that chose to early adopt ASC 606. In its Form 10-K MD&A, General Dynamics disclosed that it developed a comprehensive change management project plan to guide the implementation of the new standard. This project plan included:
- Analyzing the standard’s impact on its contract portfolio
- Comparing its historical accounting policies and practices to the requirements of the new standard
- Identifying differences from applying the requirements of the new standard to its contracts
- Developing internal controls to ensure that it adequately evaluated its portfolio of contracts under the ASC 606 five-step model to ensure proper assessment of its operating results
- Reporting on the progress of the implementation to the audit committee and the board of directors on a regular basis during the project’s duration
How does this Fortune 500 lesson relate to middle-market companies?
A key takeaway from this brief case study is to not underestimate the amount of effort it will take to implement ASC 606. The introduction and implementation of new comprehensive revenue recognition guidance brings monumental change to how many companies account for revenue and disclose revenue-related information. While both the timing and amount of revenue recognized could significantly change, the nature and extent of revenue-related disclosures will significantly change. Systems changes may be required in many cases to capture and track information needed to apply the new guidance for accounting and disclosure purposes.
Many middle market companies, especially contract-intensive companies, will have to dedicate significant resources to properly assess and implement these changes. If not properly managed in advance, these changes could be overwhelming, particularly because middle market companies usually do not have the same level of resources that large companies have to assess and implement new accounting standards.
Information regarding the new guidance in ASC 606 is available in RSM’s Revenue Recognition Resource Center. If you have questions about the new guidance or its implementation, don’t hesitate to contact your RSM representative.
1. General Dynamics is not a client of our firm, and this case study was prepared using publicly available information.