For nonpublic companies, Accounting Standards Codification (ASC) 606 – Revenue Recognition, is effective for years beginning after December 15, 2018. If you are a nonpublic company with a calendar yearend that means that changes to revenue recognition were effective on January 1, 2019! While at first glance, other industries may seem to experience a greater impact, all retailers still need to assess the impact on their various revenue streams in order to determine the change under 606. The first step in assessing the impact of 606 should be reviewing all revenue streams for the company including where revenue is generated and determining the materiality of the separate revenue streams. With that in mind, below are ten considerations retailers should be examining now:
Reviewing contracts in place – Contracts for material revenue streams should be reviewed to identify various performance obligations within each contract. Once identified, individual transaction prices should be assigned to the performance obligations. Consideration should also be given as to when revenue should be recognized on these contracts, particularly when revenue recognition occurs over time, rather than at a point in time.
Rebate programs – Retailers with rebate programs are required allocate a portion of their revenue which will be paid to a customer or credited toward a future order. In order to achieve proper over-time recognition, a reserve should be established by reducing revenue according to this estimated amount.
Sales discounts and allowances – If sales discounts only occur at a point in time, proper recognition would be to reduce the revenue at the time of sale. If there is any future discount to be used by the customer, then the retailer should also establish a contract liability for the amount they expect customers to redeem. For instance, if a retailer has a coffee program where customers can buy four cups of coffee at $1 each and then receive the fifth one for free, and they expect all fifth coffees to be redeemed, then the revenue recognized on the first four coffees should be reduced by one-fifth ($0.20) to cover the fifth sale. In total, the retailer still recognizes $4 in revenue, but spreads this revenue over the life of the entire transaction
Warranty provisions – In general, revenue on warranties sold separately from the underlying product should be recognized ratably over the life of the coverage period.
Installation – Installation that is capable of being distinct from the underlying product being sold represents a separate performance obligation must be separately allocated under ASC 606. For instance, a retailer may sell a stereo system and offer to install the product. This retailer also occasionally installs stereos not purchased through their store. As this installation could be performed by a third party, it could represent a separate performance obligation.
Rights of return – Retailers will need to assess the likelihood of products being returned and establish a contact liability for this amount as a reduction to the revenue recognized.
Franchise considerations – If you have contracts with franchise holders, these will need to be reviewed to determine if over-time recognition is more appropriate than point in time recognition. In addition, attention should be given to any fixed and scheduled payments as well as any agreements for a percentage of sales and how the revenue recognition may be impacted.
Costs to obtain a contract – Certain expenditures incurred to obtain a contract should be capitalized and then amortized in a manner consistent with revenue recognition under the contract. This could include items such as sales commissions, legal fees, advertising fees, and travel expenses.
Gift cards – In conjunction with ASU 2016-04 – Extinguishment of Liabilities: Recognition of Breakage for Certain Prepaid Store-Value Products, entities will be required to estimate expected breakage and income in proportion to their customers’ redemption patterns. Revenue for breakage should be recognized over time based on the likelihood for customers to not redeem their gift cards.
Financial reporting and disclosure – Once your company assesses the overall impact, they need to determine the adoption method through either a retrospective (restatement) or modified retrospective (disclosure of the prior-year impact in the footnotes). ASC 606 also has expanded disclosure requirements including disaggregation of the various revenue streams, outstanding performance obligations at yearend and any assets recognized from the costs to obtain or fulfill a contract.
While reviewing the impact of the changes to revenue recognition may at first seem to be a large task, breaking down the individual considerations makes the job more manageable. We have subject matter experts on staff who have helped all types of entities navigate these rules and can ensure you are ready for your yearend audit. For more information on ASC 606 please visit the Schneider Downs Our Thoughts On blog or Email us at [email protected].
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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.