Revenue is a crucial measure in assessing the performance and future prospects of any business; however, the guidance for revenue recognition varies in Generally Accepted Accounting Principles (GAAP) to International Financial Reporting Standards (IFRS). Many in the industry today are of the view that both these standards must be improved.
As of May 28th, 2014, the International Accounting Standards Board (IASB) and the FASB have cohesively issued guidance on revenue recognition in customer contracts (FASB, 2015). Slated to be a major achievement in improving financial reporting, the new guidance will have a profound impact on revenue recognition requirements in specific industries, of which real estate is the highlight.
Currently the GAAP system is not only complex, but has disparate requirements for revenue recognition in specific transactions, especially those pertaining to real estate and software. This is one of the reasons why real estate will use different accounting processes for the same economic transactions.
However, the new guidance sets forth to establish reporting principles that will provide resource to users about the uncertainty of revenues from contracts in the financial statements (Borland, 2015). The new guidance will do the following:
- Remove inconsistencies in the current revenue framework
- Provide a more robust system for revenue issues
- Improve revenue recognition assessment across industries and capital markets
- Offer resourceful information to users in the financial statements for improved disclosure
- Streamline financial statements by reducing the requirements.
How It Affects California
To begin with, lessees have already begun preparing for the new lease and revenue recognition guidance that are to take effect in 2018. According to Ellen Bartholemy, the Director of Accounting at Hall & Co., the new accounting rules will change the way recording lease payments work.
Ellen explains that there are still many people who are unfamiliar with the new standards, and one should start preparing for the changes with their accountants. She says,
“People do need to work closely with their accountants on these new rules to see the impact that it is going to have. It is going to be very important to have an accountant that is well versed in real estate. They need to be starting now, even if it isn’t going to be effective until 2018.“
What must be understood is how the lease options we have taken now, or ones that will be signed up for, will affect our balance sheets and banking as a whole. The new standards mark no exception for existing leases, so it is time you need to utilize to get started with planning.
With the accounting rules in effect, lessees will be required to record lease payments as liabilities. Conventionally speaking, lease payments are treated as disclosure items in the financial statements and are not recorded in the balance sheet. Hence, with the new standards, leasing will affect equity for a company, and subsequently, the assets and liabilities.
What is more concerning here is that the IRS is considering how the rules are going to affect taxes. In other words, a real estate agency may have to file for change in the accounting method, something that a company may not be able to do on its own (Borland, 2015).
The best way to prepare for the 2018 changes in accounting rules is to speak to your accountant. Your net worth, equity, and debt could be at stake. Getting a professional opinion will allow you to develop a plan and prepare for the worst.
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Eric Lawrence Frazier MBA
President and CEO
Borland, K. (2015, June 1). Prepare Now for 2018 Accounting Rules. Retrieved August 3, 2015.
FASB, Financial Accounting Standards Board. Retrieved August 3, 2015.