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The new revenue recognition rules prescribed by Accounting Standards Codification Topic 606 (“ASC 606”), Revenue from Contracts with Customers, went into effect for public companies on January 1, 2018, and on January 1, 2019, for private companies. However, due to the COVID-19 pandemic, private companies were given a one-year extension to adopt ASC 606; therefore, calendar year companies can now adopt as of January 1, 2020.
There are five steps defined in ASC 606 that a company will have to go through for each of its contracts under the new guidance. It will take some time for all companies, including those in the manufacturing and distribution sector, to get up to speed on the new revenue recognition landscape that will be required under accounting principles generally accepted in the United States of America (“GAAP”).
Five Most Significant Changes to Manufacturers and Distributors
Here are five of the most important changes likely to impact companies in the manufacturing and distribution sector as a result of the new revenue recognition guidance.
Consider the Effects of the New Guidance
Some manufacturing and distribution companies have simple-to-assemble products that are quickly assembled and shipped. They generally won’t have too much trouble with the rule change. But, many manufacturing companies have lengthy start-to-finish timelines in their processes, and will most likely be impacted by the new revenue recognition landscape.
Example: Let’s say an aerospace company produces a specialized part that takes three months to build. In the past, the company would use the “percentage of completion” method to recognize revenue in stages until the project was 100 percent completed. Sounds logical, right? But, some companies would wait until the entire project was finished and shipped. Revenue wasn’t always being treated consistently in the industry, and it became harder and harder to compare companies with each other. In order to address these inconsistencies in practice, the GAAP accounting rules and interpretations related to revenue recognition were becoming more and more complex, thus driving the need for ASC 606.
The new rules under ASC 606 should streamline revenue recognition accounting and provide some room for interpretation of those principles. If you’re lucky, there may be no significant change to your company’s revenue recognition policy. But you’ll still need to perform a detailed analysis in accordance with ASC 606 for each and every one of your customer contracts, which could be complicated and burdensome for some companies.
We have long known that changes were coming as a result of ASC 606, but are surprised by how extensive those changes have been, and more importantly how much prep time has been required by entities to adopt the new guidance. Therefore, it’s critical that companies start working on the implementation now. Spend some quality time looking closer at your contracts and preparing your systems to account for transactions under this new revenue recognition standard.
Be proactive. Review the Five Key Steps in ASC 606 and your key contracts. Hire an accounting consultant if adoption of the new revenue recognition standard makes you feel overwhelmed. In the long run, it will be worth getting up to speed as the new rules may result in significant changes for manufacturing and distribution companies, particularly in the areas of (a) Measuring Performance Obligations Over Time, (b) Rebates and Volume Discounts, (c) Cost to Obtain a Contract, (d) Warranties, and (e) Shipping Terms.
For more information about ASC 606, visit Revenue Recognition/ASB 606.