How the New Revenue Recognition Standard Will Impact the Transportation Industry
Under current revenue recognition standards, transportation companies generally recognize revenue upon delivery of freight to the customer. Related transportation and delivery expenses directly associated with the shipments are recorded once the revenue is recognized. This revenue recognition methodology will change with the adoption of Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606). Topic 606 is effective for public companies for periods beginning after Dec. 15, 2017 and for non-public companies for periods beginning after Dec. 15, 2018. Early adoption is permitted.
Understanding the New Standard
The FASB’s goals with the new revenue standard include removing inconsistencies and weaknesses in today’s model, improving comparability of revenue recognition practices across entities and industries, and providing more useful information to users of financial statements through improved disclosure requirements.
The core principle of Topic 606 is that an entity should recognize revenue to depict the transfer of 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. In order to achieve the core principle of Topic 606, an entity should perform the following five-step analysis:
Step 1: Identify the contract(s) with the customer
A contract with a customer can be written, oral, or implied, and must satisfy all of the following conditions to be considered a contract under the new standard:
- Be approved,
- Identify the rights of each party,
- Identity the payment terms,
- Have commercial substance, and
- Collection is probable.
The contract would generally be deemed to meet these conditions when the transportation company picks up freight from the shipper’s location, as evidenced by a bill of lading.
Step 2: Identify the performance obligations in the contract.
A performance obligation is defined as a promise in a contract to transfer goods or services. A promised good or service must be distinct to be accounted for as a separate performance obligation when there are multiples promises in a contract. In the case of transportation companies, transportation services would be expected to be the only performance obligation within most contracts. Delivery and accessorial services may appear to be separate services, but they would not be considered distinct, because a customer could not generally benefit from the accessorial services without delivery services.
Step 3: Determine the transaction price.
The transaction price is the amount of consideration to which an entity expects to be entitled to in exchange for transferring promised goods or services to a customer, excluding the amount collected on behalf of third parties, such as sales tax. For transportation companies, the transaction price may consist of the delivery charge, fuel surcharge and accessorial and other fees.
Step 4: Allocate the transaction price to the performance obligations.
The transaction price is to be allocated to various performance obligations based on standalone selling prices. As discussed above, most contracts for transportation companies will include only one performance obligation, transportation services. If the only performance obligation is transportation services, the entire transaction price is to be allocated to those services.
Step 5: Recognize the revenue.
Revenue is recognized when performance obligations are satisfied by transferring control of a promised good or service to a customer. Control either transfers at a specific point in time or over time.
In the case of transportation companies, control would transfer over time, because another transportation company would not need to re-perform the partial delivery of freight. At the same time that the transportation company provides the service, the customer receives and consumes the benefits of the service. Therefore, revenue should be recognized over time and the transportation company will need to estimate the amount of revenue to recognize on deliveries in-transit at the end of a reporting period. Certain costs related to deliveries in-transit will also need to be estimated and recorded at the end of a reporting period.
Recognizing Revenue “Over Time” Versus a “Point in Time”
The adoption of Topic 606 will require transportation companies to alter their method of revenue recognition from a point in time to over time. A transportation company can estimate the impact using a report of loads picked up before the end of a reporting period and delivered subsequent to the end of the reporting period. This report can then be used to estimate revenue on deliveries in-transit at the end of a reporting period based on the number of days completed by the end of the reporting period.
Transportation companies will need to disclose the adoption of Topic 606 and calculate its impact on their financial statements by using one of the following two methods:
- Full Retrospective Method
Under the full retrospective method, the transportation company will need to implement the standard for all years presented in financial statements in the year of adoption. If the transportation company adopts Topic 606 in 2019 and presents comparative financial statements, then both 2018 and 2019 financial results will be presented under Topic 606, which may require revision to 2018 financial statements, including the disclosure of the adjustments.
- Modified Retrospective Method
Under the modified retrospective method, the transportation company is only required to apply the new revenue standard to the financial statements for the year in which Topic 606 is adopted. This will require an adjustment to retained earnings as of the beginning of the current year to recognize the cumulative impact of the new revenue standard. In the year of adoption, the company must disclose the amount by which each financial statement line item is affected in the current year by the application of the new revenue standard as compared to the guidance that was previously in effect before the change and an explanation for the reasons for significant changes.
Based on recent public transportation company 10-Q filings, the new revenue recognition standard will not have a material impact on the financial statements of most transportation companies. That being said, all entities – including transportation companies – will need to adopt the new standard and go through the process of analyzing and documenting the five steps noted above.
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