In June 2010, the FASB issued the Proposed Accounting Standards Update for Revenue Recognition (Topic 605) which began a process that is set to massively change how U.S. corporations recognize revenue. Since 2010 comments have been made, revisions published and implementation guidance given, but there are probably many companies out there that don’t yet realize the degree of change this new standard will have, not just on presentation of their financial statements but on a myriad of systems and processes throughout the company.
The result is the new comprehensive “principles based” revenue standard, ASC 606: Revenue from Contracts With Customers. The new standard’s rules will take effect for periods beginning January 2018 for public companies and January 2019 for most private companies. That’s not much time left to plan and adjust your systems and internal processes, if you haven’t done this already. Don’t under-estimate how long this will take!
Impact on Sell-Through Revenue Recognition:
By far the biggest impact of the new guidance on semiconductor companies is going to be how revenue is recognized on sales to distributors. Many of the semiconductor companies I have worked with as a consultant and for as an employee, use a “sell through” model for revenue recognition when selling through distributors. Many distributor agreements contain rights to price protection (ship and debit agreements), rights of return, stock rotation policies, or other rebates and credits. Many of these agreements contained clauses that created uncertainty about the amount of revenue the company could recognize at the time of sale, so it made sense to defer the revenue under the old revenue recognition guidance. After all the amount of the credit could never be truly known until after the end customer information was received and the rule of conservatism would dictate it is better to defer revenue under these agreements than to recognize it at the time of sale.
Under ASC 606 this changes. Semiconductor companies will be required to make their best estimate of the final revenue through these arrangements and recognize that amount upon the sales to the distributor (“sell in” model). This change is in line with the overall principle of the ASC 606: “entity recognizes revenue 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 those goods or services.” The sale to the distributor, under the new guidance, will most likely qualify as satisfying the performance obligation to the distributor (your customer). The new standard is intentionally less “rule-based” which implicitly requires more profession judgement. You will need to determine your best estimate of the expected revenue using your companies experience with returns, rebates, price adjustments, stock rotation, etc.
Consignment arrangements are discussed in the ED and left to the entity to evaluate whether or not the other party has truly gained control of the product at a certain point in time. It will be important for companies to review their distributor agreements to ensure they support their method of revenue recognition under the new guidance.
The accounting implications are fairly obvious. Revenue will be recognized at the time of the sale and an estimate will need to be calculated and accrued for, resulting in a more accurate view of the actual transaction at the time the goods were sold. However, the impact doesn’t end there. You may have configured your accounting system to collect data and account for revenue on the sell through model which now needs to be changed. You may have deferred revenue for prior year sales that will now need to be recognized. The language in your distributor agreements will need to be reviewed, and most likely updated so that you can support your revenue recognition process. The extra time given to implement the new standard will allow for companies to be methodical and thorough about how the change will be implemented. Things like how to present comparative financial statements, what internal processes do I need to change, do I need staff with a different skill set, are just a few things that companies can start to plan for so they are not caught off guard when the change needs to be made.
I will be covering this topic during the annual Tensoft Momentum conference in San Jose September 11th and 12th.