Finance: Are You Ready?

January 3, 2018 No Comments
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For Accounting Standard Impacts

by Brandon Reinschmidt

toc_columns50pxIt’s almost here! As we push into 2018, many people in Minnesota who read this phrase may think of the Super Bowl, which is being hosted in our backyard at U.S. Bank Stadium. Unfortunately, that’s not the excitement I’m talking about. No, I’m referring to the effective date of the new revenue recognition standard.

New accounting standards are generally only of interest to “bean counters;” however, the new revenue recognition standard is arguably one of the most significant accounting changes in years and is expected to have repercussions across all companies, regardless of size or complexity.

Under current guidance, revenue recognition is built around the notion of risks and rewards. Revenue is recognized when substantially all the risk of loss from the sale of goods or services has passed to the customer. Under the new guidance, revenue recognition is based on the transfer of control over a good or service. This might seem like an indistinguishable difference; however, let’s walk through an example so you can see how this might impact your company.

Let’s say you’re a manufacturer that produces and sells medical devices to a distributor. The distributor then sells the medical devices to a retail store. Under current guidance, you might wait to report revenue until the distributor sells the medical devices to a retail store, because your company is retaining the risks following delivery to the distributor. Under the new guidance, the manufacturer will likely recognize revenue upon delivery of the medical devices to the distributor, because control over those products transfers to the distributor at that time.

The new standard focuses mainly on revenue recognition from contracts with customers. Many of you are probably thinking: “I don’t have written contracts, so I won’t be affected by the new standard.” However, contracts can be written or oral. Consider the following as you think about whether your company
has contracts with customers:

  • Have the parties made a commitment?
  • Is it clear what each party is giving and/or receiving?
  • Is it defined how much or what is being exchanged?
  • Is collectability probable?

If these characteristics are present, your company likely has contracts with customers. A transaction as simple as going into a restaurant and ordering a beer could be a contract. So, before you conclude that your company will not be affected by the new revenue recognition standard, perform a thorough assessment.

Let’s be clear, it’s not just the accountants who need to understand the effects of the new standard. What many business owners may not realize are the significant effects the new standard will have on the global aspects of their companies such as business valuations, management compensation, debt covenants, and income taxes.

The Value of Your Business: Business owners are probably asking themselves: How can an accounting standard affect the value of my company when there have been no changes to operations or cash flows? The answer? Revenue recognition timing. To the extent the new standard accelerates or delays revenue recognition, it will impact earnings multiples and similar metrics used in determining a company’s value.

Compensation of Management: Performance bonuses and other compensation based on earnings or income metrics will be impacted by the new standard, so it’s important for companies to evaluate incentive plans and determine if revisions are needed.

Debt Covenants: Many debt covenants require maintaining minimum financial benchmarks based on working capital, current ratio, debt to equity ratio and debt service coverage. The new standard could impact compliance with these covenants, due to changes in revenue recognition timing. Lenders often allow for covenant adjustments due to accounting changes, but it’s important for companies to first assess how the new standard will affect covenants and then proactively communicate with lenders to avoid covenant violations.

Income Taxes: Tax law contains specific rules with respect to revenue recognition, but there are situations where revenue recognition for tax purposes is dependent on revenue recognition for book purposes. In these instances, the new standard could have a significant impact on a company’s tax liability. The most likely transaction to fall under this scenario is advance payments. New revenue recognition timing differences could also affect book-tax differences and deferred taxes.

STEPS TO TAKE
The new standard is effective for public companies with annual reporting periods beginning after December 15, 2017. Private companies have an additional year to comply with the standard. For those of you in the private sector, do not use this as an excuse to procrastinate! Take the time to assess your company’s revenue streams under the new standard and understand how it will impact all facets of your business including those previously mentioned.

Finance executives need to begin developing a plan and educating those within their companies about the ramifications of the new standard. Company executives need to think about how this will globally impact their companies; not just from just an accounting and finance perspective, but from a sales, legal, tax, human resources, and IT perspective. With over 1,000 pages of guidance and interpretations, companies will need a long runway to adopt the standard. Many of the underlying issues won’t be evident until you begin applying the guidance to specific transactions, so it’s a good idea to start now. As Franklin Roosevelt said, “There are many ways of going forward, but only one way of standing still.”pm_endmarkred-e1320337243152


BRANDON REINSCHMIDT CPA, ABV is an Audit Senior Manager at SDK CPAs and can be reached at 612-332-9369 or BReinschmidt@sdkcpa.com.

Copyright © 2018 Minnesota Precision Manufacturing Association. For permission to use or reprint this article please contact Nancy Huddleston, publications manager for Precision Manufacturing Journal.

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