The new revenue standard also provides guidance for costs incurred while obtaining a contract. Incremental costs of obtaining a contract should be capitalized if they are recoverable. This includes only costs that would not have been incurred if that contract had not been obtained. Costs to fulfill a contract should also be capitalized if they are directly related to a contract and are expected to be recovered.
There are two methods allowed for initial implementation, the first being the full retrospective method. Under this method, the company must apply the new standard to each prior period being presented, thus restating prior years as if the new standard had always been in effect.
The second method is the modified retrospective method. Under this method the company must apply the new standard as of the beginning of the period during which the standard is first implemented (for example, as of January 1, 2019). However, this method also requires the company to disclose the amount by which each financial statement line item was affected by the adoption during the year of initial implementation. This requires tracking revenue recognition under both the old guidance and the new guidance in the year of adoption.
There are several practical expedients that are available under each method, all of which must be disclosed and consistently applied.
If using the full retrospective method, practical expedients include:
- The company can elect not to restate contracts that begin and end within the same prior fiscal year
- The company can use hindsight when estimating variable consideration for prior periods
- For all periods presented before the date of initial application, a company need not disclose the amount of the transaction price allocated to remaining performance obligations, nor provide an explanation of when it expects to recognize that amount as revenue
If the modified retrospective method is used, practical expedients include:
- The company may elect to apply the standard only to contracts that are not completed as of the date of initial application
Generally, the assessment of this five-step model should be performed on a contract-to-contract basis. However, a group of contracts may be assessed together if the company reasonably expects that the assessment would not change if each contract had been considered separately.
Judgments and Estimates
The application of the new revenue standard requires a company to make multiple judgments and estimates. Like all judgments and estimates, they should be both reasonable and supportable. Some of the most significant judgments include:
- Whether promised goods and services are distinct
- The estimated outcome of variable pricing
- The estimated standalone selling prices of performance obligations
Since this new revenue standard will impact every industry, we recommend that our business clients identify, inventory, and summarize the company’s types of contracts as soon as possible. Other things to consider include:
- What types of documents are involved in creating a contract with a customer (i.e. signed agreements or invoices)?
- What types of goods or services are typically sold? Be as detailed as possible in this assessment and include items such as warranties and options to renew a contract
- Are goods and services provided within the same contract distinct and capable of being used on their own?
- How is pricing determined and is it consistent across contracts? Do you have price lists or other pricing tools that are used for pricing decisions?
Whether you are well on your way to implementation or in the early phases of preparation, SSF’s experts are here to help you through every stage of the process. If you have questions about the new revenue recognition standard or want to learn more about how your company may be affected, contact us at email@example.com or at 925.271.8700