In May 2014, the Financial Accounting Standards Board (FASB) released its final pronouncement on accounting for revenue from contracts with customers. This new pronouncement will bring many significant changes to the way entities currently account for, record and disclose revenue related to contracts with customers.
Broadly, the new standard requires entities to perform the following steps for any contracts with a customer:
- Identify the contracts 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
A manufacturing entity should review the specific criteria for each step to determine the impact the new standard might have on its accounting. Contract manufacturers should pay particular attention to step 5, which requires an entity to recognize revenue when (or as) it satisfies a performance obligation by transferring a promised good or service to a customer. A good or service is transferred when (or as) the customer obtains control of that good or service.
Indicators that an entity has passed control to a customer include, but are not limited to, the following:
- The entity has a present right to payment for the asset
- The customer has legal title to the asset
- The entity has transferred physical possession of the asset
- The customer has the significant risks and rewards of ownership
- The customer has accepted the asset
An entity would next need to determine if control to a customer has passed at a point in time or over time. Under the new standard, an entity transfers control of a good or service over time and, therefore, satisfies a performance obligation and recognizes revenue over time if one of the following criteria is met:
- The customer simultaneously receives and consumes the benefits provided by the entity’s performance as the entity performs. For example, an entity is providing recurring services to a customer over time.
- The entity’s performance creates or enhances an asset (such as work in process) that the customer controls as the asset is created or enhanced. For example, an entity is delivering goods or services to an asset located on the customer’s site.
- The entity’s performance does not create an asset with an alternative use to the entity, and the entity has an enforceable right to payment for performance completed to date. For example, an entity is manufacturing a custom asset to the customer’s specifications.
A contract manufacturer should review the specific terms of its contracts to determine what impact the new standards might have on its accounting. The new standard could result in contract manufacturers recognizing revenue at different times compared to their current practices.
The new standard will be effective for public entities for annual reporting periods beginning after December 15, 2016 and for nonpublic entities for annual reporting periods beginning after December 15, 2017.
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This advice is not intended or written to be used for, and it cannot be used for, the purpose of avoiding any federal tax penalties that may be imposed, or for promoting, marketing or recommending to another person, any tax related matter.