The New Revenue Recognition Standard: Are You Ready?

Speak with CFOs about what’s on their minds today and you’re likely to hear: revenue recognition. A new FASB standard is currently scheduled to take effect in 2017, but the standard and its potential for retroactive adoption demand immediate attention. In short, the standard may require companies to carve new paths on internal processes and core business issues.

On its face, the new standard seems simple enough, with a five-step approach: (1) identify contracts with customers; (2) identify separate obligations in the contracts; (3) determine the transaction prices; (4) allocate the transaction prices to the separate contractual obligations; and (5) recognize the applicable revenue when a performance obligation is satisfied. However, it represents a significant shift which we detail in our Revenue from contracts with customers accounting guide.

In fact, the shift is so significant that it has the ability to affect at least six important areas: compensation and bonus plans; contracts; technology; taxation; internal controls and processes; and investor relations.

Today, I want to focus on compensation and bonus plans. Given that the new guidance could change the timing or pattern or revenue recognition, it could affect employee compensation arrangements tied to revenue or earnings. At the same time, changing those arrangements could also significantly affect a company’s accounting.

So, you ask, will the new standard affect my company’s compensation plans? Well, it depends on how closely tied the particular compensation is to revenue recognition. For example, it will affect sales commission-base plans. Yet, it might also affect cash- and stock-based plans if they take into account earnings-based performance targets. Moreover – for reasons too detailed for this piece – companies could “lose” some deferred revenue when they adopt the revenue guidance, which could affect their measurements of multi-year awards.

Faced with these challenges, there are some critical things companies should be doing now with respect to compensation and the new standard. First, companies should inventory all of their compensation plans that are tied to revenue or earnings.

Second, companies should identify whether potential modifications to these plans make sense, and if so, when to make them. Notably, this requires a delicate balance – you’ll want to mitigate the financial costs while ensuring that the compensation plans continue to meet such business objectives as employee motivation, retention, and recruitment.

Third, companies must assess whether changing existing performance targets in stock-based awards would result in additional expense recognition. You should consider this not only for existing arrangements, but also when creating new ones that go into effect before the new standard’s effective date.

Finally, companies need to factor in that the FASB has other, significant standard-setting projects such as impairment of financial instruments and leasing that might also impact corporate earnings, which in turn could impact compensation arrangements.

Overall, the new standard’s impact extends well beyond compensation arrangements. For example, you’ll need to assess your systems, processes and internal controls. Under the new rules, a larger portion of some companies’ revenues will be based on estimates, and these companies need to determine whether their internal systems, processes, and internal controls suffice. Do they, for instance, capture and process the data needed to form and monitor new estimates and to track revenue differences for book and tax purposes?

In addition, applying the new standard now gives you a chance to take a fresh look at how you’re doing business – contract terms included to address today’s bright line rules might be unnecessary under the new principles.

Accordingly, it’s critical to begin at the 30,000-foot level and consider the strategic considerations. Look across your business. Determine whose input you need, from unit heads, sales, and operations, to legal, talent, finance, tax and IT. A multi-disciplinary team can best help you determine how revenue recognition affects each function and your business as a whole.

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