How the New FASB Revenue Recognition Standard impacts Business Valuations

Updated: Mar 5, 2018

On May 28, 2014, the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) issued a new standard on revenue recognition “Revenue from Contracts with Customers” Topic 606. The new standard became effective for annual reporting periods beginning after December 15, 2016 for public entities. For nonpublic entities, the new standard becomes effective for annual reporting periods beginning after December 15, 2017.

“The core principle of the guidance is that an entity should recognize 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”[1]. Since revenue is one of the most important measures relied on by investors, this new standard will likely impact investors assessment of a company’s performance and the company’s valuation.

The objective of the new FASB is to make revenue reporting from contracts with customers consistent across different industries. Currently the guidance is complex, detailed, and revenue recognition requirements may not be comparable due to guidance that varies for transactions in industries such as software and real estate, as an example. The new guidance improves comparability of revenue recognition practices across industries and capital markets. It affects all public, nonpublic, and nonprofit entities.

Most companies are currently transitioning to the new standard which may affect the company’s timing of revenue recognition. Complying with the new guidance may also affect a company’s valuation due to changes in the timing of revenue recognition. As a result, valuation professionals need to be aware of the new FASB guidance and its impact on a company’s valuation.

[1] Source: FASB Accounting Standards Update “Revenue from Contracts with Customers” (Topic 606)