Revenue Recognition Part Two: Identify the Performance Obligations in the Contract
By Benjamin R. Ripple, CPA, Partner
As everyone prepares to adopt the new revenue recognition standards, which are applicable for years beginning after December 15, 2017 for public companies and the following year for nonpublic companies, we are taking a deeper dive into each of the five steps of the revenue recognition process. Our goal is to make understanding the 700 page original Accounting Standard Update (ASU) and the seven subsequent standard updates a little easier.
The second step of the new revenue recognition standard is one of the trickier parts of the standard. It is also a crucial part of properly recording revenue under the new standard. In this step, you are required to identify all of the performance obligations included in a contract with a customer. In accounting for these performance obligations, the standard establishes that a performance obligation should be accounted for if it is distinct or a series of distinct goods or services that are basically the same and are transferred to the customer in the same pattern.
The concept of distinct would come down to whether or not the customer can benefit from the good or service on its own or with resources that are available to the customer. The goods or services also need to be distinct in the contract.
An example for this would be if you ran a music store and sold a customer a guitar that came with strings attached. In the context of this contract, you would not need to identify the strings separately from the guitar as separate performance obligations. While the two are distinct in nature in the fact that a guitar can be purchased without strings and strings can be purchased without a guitar, they are not distinct in the context of this sale. This is because the two items are transferred to the customer together, and no additional price would be added to the guitar for the strings.
On the opposite end of the spectrum, let’s say you sell a customer a specific part for a machine the customer uses in production. If the sale of that part comes with installation and a warranty to cover the part for a year, you are now looking at three distinct performance obligations: the part, the installation, and the warranty.
The homework on this step of the process is to think about your transactions. It is very likely that a lot of them are cut and dry and only contain one performance obligation, but there are probably one or two things that the Company is involved in that get a little more complicated. Are these trickier transactions properly identified? Is there a good process in place for evaluating the transactions for all of the obligations of the Company? What might slip through the cracks?
If you need additional resources on understanding and implementing the standard, you have options. First, please reach out to your accounting service providers early to get on top of the implementation issue before it gets here. Second, FASB has set up the following website to help with transition to the new standard:
Whatever you do, please do not wait until the audit of the first period under the new standard to try to get this cleaned up. That will lead to a lot of headaches for you, your bankers, your accountants, and all of those people’s significant others that will have to deal with listening to them complain about the new revenue recognition process.
Benjamin R. Ripple Partner, Assurance Practice Leader, CPA
Ben is a partner in BRC’s assurance services. Since starting his career in 2001, Ben has worked with clients ranging from family-owned companies, to multinational corporations, to not-for-profit and governmental entities requiring A-133 audits. Ben’s industry experience includes: Manufacturing and distribution Hospitality, including restaurants and hotels Investment companies Governmental and not-for-profit entities Affordable housing […]