New Revenue Recognition Standard

Janna Fitzwater, CPA

There is a new Revenue Recognition standard that will need to be implemented for annual reporting periods beginning on or after December 15, 2018. The standard affects all entities—public, private, and not-for-profit — that record transactions using GAAP.

Manufacturers often encounter Volume Rebates which under the new revenue recognition standard, may be recorded differently than the current practice.

Below is an example of the application of the new standard to a volume rebates:

Facts: A chemical company has a one-year contract with a car manufacturer to deliver high performance plastics. The contract stipulates that the chemical company will give the car manufacturer a rebate when certain levels of future sales are reached, according to the following scheme:

The rebates are calculated based on gross sales in a calendar year and paid at the end of the first quarter of the following year. Based on its experience with similar contracts and forecasted sales to the car manufacturer for the year, management believes that the most likely rebate that it will have to pay is 5%.

How should the chemical company consider the volume rebate when recognizing revenue?

Analysis: Management defers 5% (the most likely rebate) of the per-unit price as goods are provided to the car manufacturer. Considering that experience and the forecasted usage by the car manufacturer for the year, management recognizes revenue based on the amount of estimated rebate to the extent that revenue is probable.

Management monitors this estimate at each reporting date and adjusts it, as necessary, using a cumulative catch-up approach.

Volume rebates represent variable consideration and must be estimated and recognized as a reduction to revenue as performance obligations are satisfied.

To ensure that revenue recognized would not be probable of a significant reversal, companies need to consider both qualitative and quantitative factors (susceptible to outside factors, uncertainty of consideration, company’s experience with similar contracts, large number of possible considerations, etc).

Variable Consideration- Manufacturing entities often offer sales incentives to their customers, such as volume discounts, rebates, or price concessions, which create variability in the pricing of the goods or services offered to customers. Under the new standard, if the transaction price is subject to variability, an entity would be required to estimate the transaction price by using either (1) the “expected value” (probability weighted) approach or (2) the “most likely amount” approach, “depending on which method the entity expects to better predict the amount of consideration to which the entity will be entitled.” See Rudler PSC e-tip New Revenue Recognition Standard for variable consideration example.

If you have questions about the application of the new revenue recognition standard to your GAAP financial statements, we would be glad to assist you with the application to your job situations. Contact Janna or one of our professionals at 859-331-1717.