The last few years have brought several new standards from the Financial Accounting Standards Board (FASB). While some of these new FASB standards were rolled out as far back as 2014, their effective date is for fiscal years beginning after December 15, 2018—a date that’s fast approaching. So if you haven’t yet prepared for the changes, now is a good time to start.
There are two FASB standards in particular that have a direct effect on manufacturing and technology companies:
Update 2014-09: Revenue from Contracts with Customers (Topic 606)
The importance of accurately reporting your revenue cannot be stated enough—which is why differences in accounting standards can wreak such havoc on your financial statements. For example, previous revenue recognition guidance in U.S. generally accepted accounting principles (GAAP) included broad concepts and different requirements for particular industries. On the other hand, International Financial Reporting Standards (IFRS) provided limited guidance, making them difficult to apply for more complex transactions.
Due to these differences, FASB and the International Accounting Standards Board (IASB) began a joint project to clarify the principles for recognizing revenue and develop common standards. ASU 2014-09 is the culmination of these efforts.
This new guidance requires that the following steps be followed to achieve revenue recognition:
- Identify the contract(s) with a customer.
- Identify the performance obligations in the contract.
- Determine the transaction price.
- Allocate the transaction price to the performance obligations in the contract.
- Recognize revenue when (or as) the entity satisfies a performance obligation.
Principles for revenue recognition will be consistent across the board instead of varying by industry, and a new set of disclosure requirements will lead to more thorough information regarding revenue recognition on financial statements.
Since these FASB standards apply to all contracts with customers (as long as they don’t fall within the scope of another set of standards), manufacturers and technology firms will be heavily affected by these changes. Click here for the complete update from FASB.
Update 2016-12: Leases (Topic 842)
Operating lease information will soon be moving from the footnotes of your financial statements right onto your balance sheets. This new FASB standard requires companies that lease assets such as large manufacturing equipment, vehicles and buildings to include these operating leases on their balance sheet. (Previously, they were only listed under operating expenses.) The FASB standard was introduced to make statements more transparent and ensure that they more faithfully represent a company’s leasing activities and future commitments.
Given the high volume of equipment involved in the manufacturing process, this standard will likely have a significant impact on manufacturers and tech firms that focus on tangible goods. This is because such firms often opt to lease larger equipment due to its scalability (you can add to or reduce amount of equipment more easily to adjust to market conditions) and economy (leasing company is generally responsible for repairs). Your company’s obligations to these leases will now be more easily seen on financial statements so that they can more accurately reflect your financial situation.
There are also changes to the criteria of a finance lease—formerly known as a capital lease—which is set up so that ownership rights are transferred to the lessee during the contract term. (By contrast, an operating lease does not transfer ownership.) The new criteria for a finance lease are as follows:
- The lease transfers ownership of the underlying asset at the end of the lease term.
- The lease grants the lessee an option to purchase the underlying asset and the lessee is reasonably certain to exercise that option.
- The lease term is for the major part of the remaining economic life of the underlying asset. This criterion shall not be used for classification purposes if the commencement date falls at or near the end of the asset’s economic life. (The previous guidance specified “75%” instead of “the major part” in this item.)
- The present value of the sum of the lease payments and any residual value guaranteed by the lessee equals or exceeds substantially all of the fair value of the underlying asset. (The previous guidance specified “90%” instead of “substantially” in this item.)
- The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term. (This is a new item.)
The changes to this list might seem minor, but they have major ramifications. Specific figures gave some lease participants the ability to find loopholes and classify their contracts as operating leases. By removing these figures, FASB is introducing judgment that has to be supported. Click here for FASB’s complete guide to this update.
Update 2017-01: Business Combinations (Topic 805)
If your company acquires a business, you’re required to record the transaction as such. However, there was some ambiguity on the definition of “business,” leading to some confusion as to the difference between an actual business acquired and an asset that was purchased.
In response to feedback that the definition of a business was too broad, FASB issued ASU 2017-01 to better differentiate between a business and an asset.
Under previous guidance, an acquisition was determined to be a business if it included three elements: inputs, processes and outputs. The new framework also includes a preliminary “screen” that can help an entity quickly determine whether an acquisition is a business (and therefore must be documented as such) before having to evaluate for the three elements.
This new guidance affects a narrower swath of the manufacturing and technology industries—individuals and companies that acquire other companies. There are significant accounting differences between such a transaction and the purchase of an asset, so it’s critical that your financial and reporting practices reflect the transaction accurately. Click here for more information about FASB standards.
As with any FASB standard update, how these affect you and your organization can vary greatly depending upon your situation. That’s way it’s important to check with your CPA firm to ensure that you’re compliant with these and all other FASB standards.
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