There is a new global accounting standard for how businesses recognize revenue which may have significant impact for the electronic components industry. The new revenue recognition rule was developed jointly by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) and published in final form on June 14, 2014. Public companies using General Accepted Accounting Principles (GAAP) will be required to apply the new rule for annual reporting periods beginning after December 15, 2016. U.S. nonpublic companies and organizations are to apply the revenue recognition rule beginning after December 15, 2017.
The new standard sets forth a five-step process for recognizing revenue. These five steps are:
- Identifying the customer agreement
- Identifying the performance obligations under the agreement
- Determining the transaction price for each obligation
- Allocating the price to each separate performance obligation
- Recognizing revenue as each performance obligation is met or delivered to the customer
The core principle behind the new standard is that businesses must recognize revenue in the amount that the business expects to receive in exchange for goods and/or services. Recognition occurs when the title (control) over the product/service transfers from the seller to the buyer. It is no longer about earnings, but about more accurately reflecting assets and liabilities on the balance sheet.
Here are some of the possible ways that the new accounting standard may affect the electronics industry:
- The standard replaces all industry-specific accounting standards that currently exist.
- The “sell-through” accounting approach often used in connection with distribution is no longer valid. Under the new standard, revenue is recognized by a manufacturer when the product/service is sold to a distributor. The sell-through rule enabled manufacturers to delay the recognition of revenue until the products/services were sold by the distributor to the customer.
- Businesses must estimate the likelihood and cost of returns. Estimated returns create a liability and asset on the balance sheet and revenue should not be derecognized until a return occurs or the right to return lapses. For component manufacturer and distributors, the new rule has implications for stock rotation, returns and scrap allowance policies.
- Businesses must also estimate the likelihood and cost of price protection. This has implications for the ship from stock and debit practice within the industry.
- Businesses must determine whether a performance obligation is “at a point in time” or “over time.” If “over time,” then businesses must recognize revenue when each specific performance is completed. The transfer of IP licenses where royalties are involved is one example of a situation where “over time” recognition may occur.
- FOB might create a performance obligation for risk of loss in shipping, in which case there are two obligations for which a business must calculate the likelihood and cost of each obligation.
- Returns should be treated as a variable obligation.
ECIA encourages members to educate themselves about the new revenue recognition rule and have conversations with their accountants about the impact of the rule change on their business operations.
ECIA has identified two useful resources for more information.