Revenue Recognition Part Three: Determining the Transaction Price
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 third step of the new revenue recognition process, determining the transaction price, is typically one of the easier steps in the process, but it is not without some potential pitfalls. The majority of the transactions we deal with on a daily basis are the sale of a good or service for a set price. Even if the transaction includes multiple pieces, such as installation, service agreements, warranties, or other bells and whistles, there is usually an all-in price the customer agrees to before any goods or services are transferred. This all-in price would be the transaction price that you are trying to determine in step three.
However, there are transactions that are not so straight forward. For example, we might enter into a contract with a customer to prepare his or her tax return and the fee for that engagement might be 15% higher if the return is filed without extension. We would have to estimate the likelihood of completing the return before April 15th based on our history with the client, the rest of the work we are trying to complete, and any other factors we know about the situation. Then based on that estimate, we would set the transaction price accordingly. Luckily for us, we are a cash basis partnership. So, we would just recognize the revenue when we got paid, but most of you will not be so lucky if you find yourself in a similar situation.
Other items that might cause a fluctuation in the transaction price would be the existence of a significant financing component (which requires the consideration of time value of money if the financing component will extend greater than one year), noncash consideration received in a transaction, and consideration payable to the customer. An example of consideration payable to the customer would be if you have a loyalty card where every tenth oil change is free. Under those circumstances, a portion of the first nine oil changes should not be recognized as revenue until the tenth oil change is cashed in for free. Further complicating this would be the fact that everyone will not keep up with their loyalty card, so the percentage held back from each oil change would not be a simple tenth of the total.
For this step, you should be thinking about whether or not your company has transactions with customers where an all-in price is not established at the beginning of the agreement. If so, how do you currently calculate what should be recorded in revenue? Is the process supported by historical evidence or just an educated guess? What support will be available for your auditor to review for your educated guesses, or is it all in the old steel trap between your ears?
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 setup the following website to help with transition to the new standard:
FASB/IASB Joint Transition Resource Group for Revenue Recognition
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 […]