Until implementation of the new revenue recognition standard, most manufacturing companies found the rules for revenue recognition fairly easy to follow. However, the new standard may present fresh challenges to manufacturers, especially those who followed industry-specific guidance.
First, let’s get a general overview of the new standard. There are five steps to be considered prior to recognizing revenue:
- Identify the contract(s) with a customer
- Identify the performance obligations in the contract
- Determine the transaction price
- Allocate the transaction price to the performance obligations in the contract
- Recognize revenue when (or as) the entity satisfies a performance obligation
Simple or complex manufacturing contracts
Let’s look at some details. If your company manufactures and sells products through channels that only include simple contracts, such as purchase orders, there is a good chance that you will not be significantly affected by the new standard. However, if you manufacture products that are sold through complex contracts, manufacture custom products, have multiple deliverables, or extended contract terms, you may see changes in the way you recognize revenue. Under the new standard, you will need to pay special attention to all contract extensions, unpriced change orders, sales of additional goods, and any other contract modifications. Why? Because these conditions may affect the amount and timing of recognized revenue. Some contract changes may result in new contracts, while others are just the extension of contracts already in place.
When identifying the performance obligations in your contracts, keep in mind that if a good or service is sold separately by your company, but also sold as part of a package, that good or service is probably a separate performance obligation. For example, if you sold a product that included a warranty for defects in workmanship and certain life-limited parts, the first part of the warranty (defects) would be accounted for as a loss contingency. The second part of the warranty (life-limited parts) would require that a portion of the sales price be attributed to it and recognized as income based on historic experience with such warranties.
The standard does not go into effect for private companies until periods beginning after December 15, 2018. However, to comply with that date, you will need to know how the timing and recognition of revenue will be presented in your comparative financial statements by the beginning of 2018. Please keep in mind there are also several financial statement disclosures that may be required, and internal systems may need to be modified in order to collect all needed information.
The new revenue recognition standard may have a significant impact on your operations. We will keep you informed as implementation continues.
Jon Herdlein is a principal based out of our Buffalo, NY office.