Tuesday, May 30, 2017
8-Step Checklist: Get Ready for the New Rev Rec Rules
Posted by Michael Boulton
The last few years have brought an avalanche of changes to how nonprofits report their financial results. While you likely are already deep in the details of the new nonprofit financial reporting standard, there’s one more set of rules you can’t afford to ignore: the new revenue recognition standard.
This guidance, also known as ASC 606, adopts the core principle that revenue should be recognized when customer performance obligations are met. The rule affects every nonprofit entity with earned income or “exchange transactions” (your organization generally provides a product or service in exchange for a fee). Examples of exchange transactions include things like tuition, memberships, subscriptions and royalty agreements. Certain types of grants also can be considered exchange transactions.
The new standard will be effective for most nonprofits in annual reporting periods beginning after December 15, 2018.
8 Steps for a Smooth Rev Rec Transition
The implementation date might seem like it’s far away, but considering the potential changes to systems and processes, nonprofits need to start preparing now, if they haven’t already. Here is an eight-step checklist you can use as a guide.
Step 1: Inventory your revenue streams. Capitalize on the opportunity to take a hard look at all revenue streams, large or small. Reevaluate revenues to ensure you have adequate documentation supporting earned revenues and fully understand all performance obligations to your “customer.” For each revenue stream, determine whether it is an exchange transaction, a contribution or a hybrid. An example of a hybrid transaction might be fundraising event tickets in which the attendees receive goods and services of less value than the total ticket price. Since only the exchange transaction is subject to the new standard, be sure you understand the fair value of goods and services provided versus the remaining donation.
Step 2: Stay educated. Discuss the new standard with your CPA, your financial institutions and your attorney. Also seek out and attend webinars or conferences on the standard.
Step 3: Create a plan for compliance. Analyze the impact of the new standard on processes and practices throughout your organization. Compliance may require updates to financial systems and processes to collect necessary data. Consider looking beyond the finance and accounting departments. For example, what changes will you need to make to the language used in your earned revenue contracts? Will your ERP system be able to handle bifurcation with respect to multiple performance obligations or hybrid transactions, or will you need to track such items manually?
Step 4: Review your plan with your bankers, auditors and tax advisers. Discuss with bankers how adjustments in revenue recognition will affect bank covenants or other external reporting requirements. Will you need to renegotiate? Get guidance from your tax adviser to determine how changes in timing of revenue recognition may impact unrelated business taxable income or deferred taxes. Lastly, be proactive with your auditor and present your proposed plan before your year-end audit.
Step 5: Review current accounting systems. Assess the potential impact of the standard on your accounting and information systems. Evaluate how those systems will need to change to support the new standard and related disclosure requirements. Perhaps this is the reason you need to finally upgrade your system.
Step 6: Review contracts. The standard’s five-step revenue recognition process begins with identifying each contract and the related performance obligations. Many nonprofits have numerous arrangements covering a wide variety of products or services. Consider whether contract language needs to be updated to assist in complying with the new revenue recognition requirements.
Step 7: Review and revise internal controls. Certain controls may need to be updated to accurately capture and recognize the organization’s revenue under the new standard. For example, if your accounting system cannot handle separating multiple performance obligations under one contract, and you decide manual intervention is most economical for your organization, you should consider implementing an appropriate internal control to review and approve such manual calculations. Or if you have not historically maintained a contract review control, take this as an opportunity to implement one, and determine the appropriate thresholds requiring executive approval of earned revenue contracts.
Step 8: Educate board and finance committee members. Help these stakeholders understand how the new standard may change your organization’s financial statements. Inform them of your transition plan and any foreseeable concerns. Invite collaboration and discussion as much as possible.
ASC 606 is a big overhaul of the revenue recognition rules. Don’t underestimate the effort it will take to prepare for compliance with this significant new standard.
Need guidance on implementing the new revenue recognition rules? Our seasoned nonprofit experts can help make the transition as smooth as possible.
Michael is a Senior Manager in the audit department at Armanino, where he specializes in financial statement audits, reviews and compilations. He is a Certified Public Accountant and an active member of the American Institute of Certified Public Accountants (AICPA) and California Society of Certified Public Accountants (CalCPA).