By Mark Henry
After years in the making, the revenue recognition standards have officially changed for privately-held companies, effective January 1, 2019. The implementation of the new standards could immediately impact your tax situation, and/or change how much revenue you are recording today, your banking covenants, and some of your compensation and commission plans that are tied to revenue or gross profit metrics. The new revenue recognition standards may also influence decisions related to the future sale of your company, changes in ownership, or the value of your company.
So, where do you start? What questions should you be asking yourself, your management team, and your CPA firm to consider how these changes may affect you? The following are some of the major changes to consider that will impact your industry.
Discounts and rebates: If you offer discounts and rebates to customers, based on achieving various sales thresholds (i.e. – the more they buy, the bigger the discount they can receive), on the first day of entering into that agreement, you will need to estimate the likelihood of a discount or rebate they will receive and record revenue at that net amount. As the agreement progresses you can adjust your estimates until all services have been performed.
Product and service warranties: Most companies have a standard product warranty which assures that the product customers buy will function as intended. The new standards do not change the accounting for those warranties. New guidance does, however, impact extended product warranties and service warranties sold in conjunction with a product. These warranties need to be recorded at their fair value over the periods they relate to. For example: You sell your product with a free service warranty added in, to entice the customer to buy the product. In this case, the selling price would need to be allocated to the product and the warranty based on their relative fair values. This would likely lead to a timing difference in revenue recognition from current practice.
Bill and hold arrangements: Do you sell goods to your customers but hold them until a later date so they can pick them up at their convenience? Current guidance would allow that sale to be recorded once the product is ready for customer pick-up. Under new guidance, the company will have to review the portion of revenue related to the sale of the good, and separate the portion of revenue associated with warehousing for time it is held for the customer. This would likely lead to a timing difference in revenue recognition from current practice, with the product sale being recorded at a point in time, and the warehousing of the goods being recorded over a period of time.
Drop shipments: Currently most drop-ship arrangements are recognized on a “gross” revenue basis, along with the “gross” cost of goods sold. Under the new standards, you may have to record this revenue on a “net” basis. For example: You sell a product to a customer that is shipped directly from the wholesaler, but that product never touches your hands – you only coordinate the sale and bill the customer. Ask yourself the following questions: Who ultimately bills for the product? Who has control of the product during shipment? Do returns come to you or the supplier? Who has pricing discretion? Although these changes will not impact your gross profit, the answers to these questions could significantly lower the revenue you have previously been recognizing.
Sell-through method: If you sell products to distributors who ultimately have the ability to ship back products if they are unable to sell them, current guidance would not allow you to record a sale. Under the new standard, you will need to estimate the revenue, based on the transfer of control to the distributor, and on historical experience, customer experience, and likelihood of sales. This will likely result in acceleration of revenue.
If you are impacted by any of the above items, the time is now to address them and avoid surprises at the end of the year. Talk to your financial counsel to ensure you understand the changes and are prepared to make the necessary adjustments moving forward.