When it comes to financial reporting, timing matters.
The end of the accounting period serves as a hard “cutoff” for recognizing revenue and expenses—but during the COVID-19 pandemic, managers may wish to show earnings or reduce losses, and may want to delay reporting expenses until the next period or extend revenue cutoffs beyond the period’s end.
The following is an overview of the U.S. Generally Accepted Accounting Principles (GAAP) rules applying to revenue and expense recognition.
Revenue and expense recognition under GAAP
Rights of ownership include possession of an unrestricted right to use the property, title, assumption of liabilities, insurance coverage, transferability of ownership, and risk of loss. Under GAAP, companies recognize revenue once the earnings process is complete and the buyer has assumed rights of ownership from the seller.
In addition, under GAAP, the exchange of cash doesn’t necessarily drive the recognition of revenue and expenses. Under accrual-based accounting methods, revenue and expenses are matched in the reporting periods that they’re earned and incurred. For certain services and contract sales, the rules may be less clear, which may tempt some companies to artificially boost financial results by playing timing games.
Changes in long-term contract rules
Under Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, the rules involving cutoffs were recently changed for companies entering into long-term contracts. According to the Standards update, revenue should be recognized “to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for the goods or services.”
Under this new guidance, management must make judgment calls when it comes to identifying performance obligations, or promises, in contracts, as well as in allocating transaction prices to these promises and estimating variable consideration. These judgments might allow for manipulation or management bias.
However, the need for expanded disclosures and the risk of misstatement will bring increased scrutiny to revenue recognition practices. As such, businesses affected by the updated guidance can expect to see their auditors ask more questions about cutoff policies and perform additional audit procedures to test GAAP compliance. Auditors will likely review a larger sample of invoices and customer contracts than in previous periods, for example, in order to ensure that the cutoff rules are being applied accurately.
Contact us today
If you have questions about the rules on when to record revenue and expenses, contact us today. We can assist you in staying compliant with the current guidance and minimizing your audit adjustments.