Updated guidance on revenue recognition standards will soon affect nearly all U.S. nonpublic companies, and you’ll need to comply with these provisions in your calendar year 2019.
In May 2014, the Financial Accounting Standards Board (FASB) issued new comprehensive principles-based rules on revenue recognition, scheduled to broadly impact U.S. companies issuing financial statements. The standard aims to provide one core model for companies to recognize revenue. This will replace the various divergent methods existing currently, as the literature surrounding the generally accepted accounting principles (GAAP) is primarily based on an entity’s industry focus.
Who is affected?
The FASB’s updated guidance generally applies to all entities industry-wide, including private companies, public companies, and non-profit organizations. The new model does not impact revenue recognition related to insurance contracts, leases, financial instruments, or certain non-monetary exchanges.
U.S. nonpublic entities issuing calendar year-end financial statements must implement the new revenue standard in 2019. U.S. public companies were required to adopt the standard one year earlier in 2018.
Basic core principles
Under the new revenue recognition accounting model, companies will recognize revenue using a single standard that faithfully depicts the transfer of promised goods or services to customers in an amount the entity expects to receive in exchange for those goods or services. During the evolution of U.S. GAAP, both transaction- and industry-specific guidance evolved. This created inconsistencies across entities, resulting in different accounting for similar transactions and different disclosure requirements for an issuer’s financial statements.
FASB provided five steps to achieve this core principle in recording the timing of revenue recognition.
The following is a list of the most relevant issues for the transportation and logistics industry as it relates to the new revenue recognition standard.
Step 1 – Identify the contract with a customer
The new revenue standard defines a contract as an agreement that has all of the following characteristics: it is between two or more parties; it creates enforceable rights and obligations; and it is in the form of a written agreement, a verbal agreement, or an arrangement implied by the entity’s ordinary practices when conducting business.
Customary business practices
Our take: Under the new standards, as long as the carrier has enforceable rights, simply following customary business practices would constitute a contract, which could be represented as individual customer orders supported by pricing negotiated with the shipper.
Master service agreements (MSAs)
Our take: A contract does not typically exist until a bill of lading is issued indicating the enforceable rights for loads that have been picked up by the carrier. If there is a master service agreement in place, this agreement alone likely does not provide enforceable rights between the carrier and shipper.
Step 2 – Identify the separate performance obligations in the contract
The new revenue standard defines a performance obligation as a promise within a contract with a customer to transfer any of the following: a distinct good, a distinct service, a build of goods and services, or a series of distinct goods or services that are basically the same and are provided to the customer in the same pattern.
Interrelated performance obligations
Our take: The single performance obligation performed by a carrier is typically transportation services. As part of completing its service obligations, a carrier may perform services in addition to freight services, such as loading and unloading or other accessorial services. These services are not distinct from freight services, as they are highly interrelated to the trip completed by the carrier. The entire trip and related revenue is typically accounted for as only one performance obligation under the new revenue recognition model.
Principal versus agent considerations
Our take: In most situations, a carrier who utilizes an owner-operator as part of its carrier model will still be considered the principal and will record revenue on the gross basis at amounts charged to the customer. The rationale is that the carrier has contracted with a customer to provide services and the carrier is legally responsible to fulfill the terms of the contract. The carrier also typically invoices the customer, and has the ability to negotiate prices with their customer, further showing evidence of their control over the services to be performed.
Step 3 – Determine the transaction price
An entity must determine the transaction price based on the terms of the contract and the entity’s customary business practices. An entity must use its judgment to determine the amount of consideration to which it is entitled.
Our take: For a carrier, the transaction price will likely include mileage revenue, fuel surcharge, and the accumulation of accessorial fees. Some of the consideration for the carrier will be variable based on the determination at final delivery.
Significant financing component
Our take: The nature of the transaction services provided in carrier operations is typically short term. As such, there is not a significant financing component to be accounted for as it relates to these revenue transactions. This aspect of the new standard is not likely to have much applicability unless the terms with the customer are considered unreasonable.
Step 4 – Allocate the transaction price to the separate performance obligations in a contract
If a contract has only one performance obligation, the transaction price is allocated entirely to that one performance obligation. If a contract has multiple performance obligations, an entity must determine an appropriate allocation of the transaction price to those multiple performance obligations.
Our take: In most instances, the transaction price will be allocated to transportation services as the carrier’s single performance obligation.
Step 5 – Recognize revenue when (or as) performance obligation are satisfied
A performance obligation is satisfied when (or as) an entity transfers a promised good or service to its customer. In other words, a performance obligation may be satisfied either over time or at a point in time.
The transfer of a promised good or service to a customer occurs when the customer obtains control of the item. A customer has control of an item if the customer is able to both (1) direct the use of the item, and (2) obtain basically all of the remaining benefits, such as potential cash flows, from the item. The timing of revenue recognition under the new guidelines is when control of the goods or services under the contract transfers to the customer.
In the basis of conclusion in the standard, the FASB noted freight revenue should theoretically be recognized over the period of time the shipments are provided for customers — shippers receive the benefits of goods being moved from origin to the destination versus at the point in time at delivery. The FASB acknowledged that practical limitations may exist in whether another carrier would be able to take over the remainder of the trip for an incomplete shipment, but indicated that this fact should be disregarded under the guidance for the revenue recognition model. Therefore, under the new revenue standard, a carrier’s revenue recognized will consist of freight delivered during the period, as well as a proportion of revenue for service deliveries that are in process as of the end of the reporting period.
Measuring progress over time
Our take: For recognizing revenue, the new standard requires a carrier to recognize revenue over time as shippers simultaneously receive the benefit of the services over the course of the respective trip. This is likely the most significant impact of the new standard related to the industry.
Under the old revenue recognition guidance, carriers typically recorded revenue at the time when a delivery was completed at a destination location. To comply with the new revenue recognition standard, calculate the revenue in transit as of the end of a reporting period using a method such as the number of days completed for each trip at year-end, or the distance traveled as of year-end in comparison to the total trip distance of each respective trip in progress. At the end of a reporting period, based on the analysis performed by management to quantify the revenue and cost components of each trip in progress, the timing of revenue recognition is expected to change under the new revenue recognition standard.
Effective date and transition measures
For nonpublic companies, the new revenue standard is effective for annual reporting periods beginning after December 15, 2018. The guidance provides two alternative transition methods that you may elect to adopt:
- A retrospective approach that provides an entity with certain optional practical expedients
- A retrospective approach under which the cumulative effect of adopting the standard is recognized at the date of initial application
Our take: In determining which method to elect, consider not only which method is easier to apply, but also what the expectations are of the investor community. In the majority of instances, we anticipate nonpublic companies will select the cumulative effect approach. For a calendar year nonpublic company, with the effective date required to adopt the guidance, an adjustment will be required to be made on January 1, 2019 to record the effect of adopting the new standard. After considering the impact of the new standard, the general form of the adjustment for a carrier is as follows.
|December 31, 2018||Opening journal entry||January 1, 2019|
|Contract assets (in-transit revenue)|
|Contract liabilities (in-transit cost)|
How we can help
With the extent of the changes in the new revenue standard, it will be vital for you to plan for and then execute the implementation process. Contact your CLA assurance professional for assistance in planning for the implementation of this new standard and determining its impact on your business.