US companies are scrambling to adjust to a change in accounting rules that has been more than a decade in the making.
The new Accounting Standards Update (ASU), otherwise known as ASC 606, is intended to reduce the differences between US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS).
Complete implementation of ASC 606 is required for 2018 financial reporting by public companies (with an additional year for nonpublic entities). While a few have already switched to the new standard, a survey conducted earlier this year by global accounting firm EY revealed that more than 70% of listed firms had not yet completed their revenue recognition programs, and 14% had not even started assessing the new guidelines.
“[ASC 606] is a big and important change and has high implementation costs for firms,” says Lucy Chen, associate professor of accountancy and information systems at Villanova University School of Business. “That’s also why the Financial Accounting Standards Board decided in 2015 to propose a one-year delay of the effective date.”
Under the new standard, vendors under contract to provide goods or services to a customer will have to follow a five-step process that requires more judgments and estimates than before in determining revenues and costs.
“The revenue standard for GAAP was rules-based and contained a lot of industry-specific guidance, hence it was not consistent across different industries,” says Chen. “Under IFRS, it is more principles-based and applicable across different businesses around the globe.”
Sectors most impacted by the change include aerospace and defense, automotive, media and telecommunications. The FASB hopes to make comparisons under IFRS and GAAP rules easier, Chen says, but analysts and investors will have to be particularly mindful in the early stages. A change in the timing of when revenue and costs are recognized will affect the way key performance measures are reported, but it will not reflect a real difference in a business’s underlying fundamentals.