As we’re learning, the new revenue recognition standards are more principle-based than the existing system. Two industries that should take heed of this–and can be expected to exercise more judgement–are the retail and consumer industries. The new standards may impact those sectors more than the folks who work within them realize. For example, companies with retail and consumer products will have to re-think how to estimate returns and account for loyalty programs. Those firms might also need to alter how they recognize sales taxes.
The new revenue recognition standards jointly issued by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) will supersede virtually all existing revenue recognition guidance under US GAAP and IFRS, including industry-specific guidance. The new standards provide accounting guidance for all revenue arising from contracts with customers and impact all entities that enter into contracts providing goods or services to their customers (unless those contracts are in the scope of other US GAAP requirements, such as the leasing literature).
Retail entities need to re-evaluate the inner-working of loyalty programs, reseller arrangements, licensing and franchising models. Assistance in such evaluation is starting to become available. It is recommended that retail and consumer product bodies closely monitor discussions of the Joint Transition Resource Group (TRG), formed this year by the IASB and FASB to help determine whether more implementation guidance or education is needed. The TRG is not responsible for any formal recommendations to either board and does not issue any guidance. The AICPA (American Institute of Certified Public Accountants) has also established task forces and is preparing to aid industry stakeholders in implementing the new standards. This is likely to be a great boon to entities with retail and consumer products.
Summary of the new model
The new guidance outlines the principles an entity must apply to measure and recognize revenue and related cash flows. The core principle is that an entity will recognize revenue at an amount that reflects the consideration to which the entity expects to be entitled in exchange for transferring goods or services to a customer.
The principles in the standard are applied using the following five steps:
1. Identify the contract(s) with a customer
2. Identify the performance obligations in the contract
3. Determine the transaction price
4. Allocate the transaction price to the performance obligations in the contract
5. Recognize revenue when (or as) the entity satisfies a performance obligation
Retail and consumer product entities will need to exercise judgment when considering the terms of their contracts and all the facts and circumstances. These businesses will need to consider all contracts that are legally enforceable, including implied and oral contracts. Entities will also have to apply the requirements of the new standard consistently to contracts with similar characteristics and in similar circumstances.
For retail and consumer products entities, identifying the contract with a customer under the new model will be similar to how it is done today, but entities will need to evaluate the legal enforceability of all contracts and collectability of each. A contract generally exists at either the point of sale, when goods or services are delivered or a sales agreement is executed.
Retail and consumer product entities entering into other contracts, such as franchise or licensing arrangements, will need to evaluate the terms of each contract to see whether or when criteria in the new standard is met.
Entities will have to assess whether current models for estimating returns are appropriate given the required methods for estimating the transaction price (i.e., the expected value or the most likely amount method) and the requirement to apply the constraint on variable consideration. While the method for estimating expected returns will change, the outcome may remain the same.
Retail and consumer product entities that currently apply the incremental cost method will need to change the process for recognizing loyalty or reward programs if those programs provide a material right to customers. Those companies will need to apply significant judgment to estimate the standalone selling price of the award credits. This likely will require changes to accounting policies, accounting systems and/or internal control over financial reporting for a business.
Because consideration paid to a customer can take many forms, entities must carefully evaluate each transaction or type of transaction to determine the appropriate treatment of such amounts. Entities will also have to determine whether to incorporate consideration paid/payable to a customer in the transaction price at contract inception or at a later date.
Retail and consumer product entities offering goods or services through multiple delivery channels will need to consider the promised goods or services to determine whether multiple performance obligations exist. If more than one performance obligation exists, entities will need to determine the number of performance obligations and when each performance obligation has been satisfied (i.e., when revenue should be recognized).
• Entities should perform a preliminary assessment of the impact of the new revenue recognition standards as soon as possible to determine how to prepare and implement. While the effect on entities will vary, some may face significant changes in revenue recognition. All entities will need to evaluate the requirements of these new standards and make sure processes, systems and controls are put in place to collect the necessary information for implementation, even if accounting results won’t change significantly or at all.
• Entities should consider monitoring discussions of all applicable boards, the SEC staff and the newly formed TRG.