Updated Revenue Recognition Standards: The Impact On Small Business
In December 2017, the accounting standards for revenue recognition were updated to reflect changes in best business practices. These changes were applied to all entities that use GAAP, or Generally Accepted Accounting Principles, accounting standards. (Technically only public entities were required to use the new standards immediately, but private entities will be required to be retroactively compliant once the standards are in place for them come December of 2018.)
Small businesses need to be aware of these changes and alter how they do business accordingly, in order to remain compliant and (more importantly) stay in business with other compliant companies. Breaking down the changes into pieces is the easiest way to know how these new standards can affect you.
- Understand what is a contract under the new GAAP standard, and whether or not any deal you close counts as a contract. The new standard says contracts do not have to be written (ie. oral contracts are acceptable), but specific goods, services, and payments must be spelled out and agreed upon; it must make clear who gives and who receives under the arrangement, with the rights of both parties clearly stated; and it must have “commercial substance”, or in layman’s terms, be worth something (you can expect to be paid).In addition, business IT systems must now track the start and end date for contracts.
- Performance obligations must be broken down into separate pieces. Items used by the customer are considered ‘distinct’ if they can be used on their own, and ‘not distinct’ if they can only be used in conjunction with other purchased items. Each good or bundle of goods is considered a single performance obligation.
- With regards to transaction price, the new standard introduces new considerations. Discounts, rebates, refunds, and royalties must be accounted for in the price. If goods and services are used in lieu of cash, they must be exchanged at fair value.
- Revenues should be recognized as each distinct performance obligation is completed, again including discounts, rebates, and sales. Likewise, revenue must be separated by each performance obligation satisfied.
The critical takeaway for small businesses and their employees is the change in the timing of revenue recognition. Because revenue must be accounted for as each obligation is satisfied, rather than at the end of a contract or via some other method devised by the companies, any payment structure linked to revenues can potentially be affected. Most commonly this will impact commission payments, but the largest changes may come to periodic (especially annual) bonuses. Furthermore, ignoring this change is not a feasible option; if GAAP standards are not maintained, the business may be susceptible to legal challenges.
Running a small business requires filling multiple roles at once, and keeping track of accounting standards aimed at professional accountants can require effort best aimed at running the company. If you’re interested in hiring professionals to handle these changes, and all your other accounting needs, contact us to find out how we can help.